by National income is the value of the aggregate output of the different sectors during a certain time period. In other words, it is the flow of goods and services produced in an economy in a particular year. Thus, the measurement of National Income becomes important.
Measurement of National Income
There are three ways of measuring the National Income of a country. They are from the income side, the output side and the expenditure side. Thus, we can classify these perspectives into the following methods of measurement of National Income.
Methods of Measuring National Income
- Product Method
- Income Method
- Expenditure Method
Product Method:
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.
National income
Goods which are further used in production process are called intermediate goods. In the value of final goods, value of intermediate goods is already included therefore we do not count value of intermediate goods in national income otherwise there will be double counting of value of goods.
To avoid the problem of double counting we can use the value-addition method in which not the whole value of a commodity but value-addition (i.e. value of final good value of intermediate good) at each stage of production is calculated and these are summed up to arrive at GDP.
The money value is calculated at market prices so sum-total is the GDP at market prices. GDP at market price can be converted into by methods discussed earlier.
(A) Gross Domestic Product (GDP):
GDP is the total value of goods and services produced within the country during a year. This is calculated at market prices and is known as GDP at market prices. Dernberg defines GDP at market price as “the market value of the output of final goods and services produced in the domestic territory of a country during an accounting year.”
There are three different ways to measure GDP:
Product Method, Income Method and Expenditure Method.
These three methods of calculating GDP yield the same result because National Product = National Income = National Expenditure.
1. The Product Method:
In this method, the value of all goods and services produced in different industries during the year is added up. This is also known as the value added method to GDP or GDP at factor cost by industry of origin. The following items are included in India in this: agriculture and allied services; mining; manufacturing, construction, electricity, gas and water supply; transport, communication and trade; banking and insurance, real estates and ownership of dwellings and business services; and public administration and defense and other services (or government services). In other words, it is the sum of gross value added.
2. The Income Method:
The people of a country who produce GDP during a year receive incomes from their work. Thus, GDP by income method is the sum of all factor incomes: Wages and Salaries (compensation of employees) + Rent + Interest + Profit.
3. Expenditure Method:
This method focuses on goods and services produced within the country during one year.
GDP by expenditure method includes:
(1) Consumer expenditure on services and durable and non-durable goods (C),
(2) Investment in fixed capital such as residential and non-residential building, machinery, and inventories (I),
(3) Government expenditure on final goods and services (G),
(4) Export of goods and services produced by the people of country (X),
(5) Less imports (M). That part of consumption, investment and government expenditure which is spent on imports is subtracted from GDP. Similarly, any imported component, such as raw materials, which is used in the manufacture of export goods, is also excluded.
Thus, GDP by expenditure method at market prices = C+ I + G + (X – M), where (X-M) is net export which can be positive or negative.
Gross and Net Concept
Gross emphasizes that no allowance for capital consumption has been made or that depreciation has yet to be deducted. Net indicates that provision for capital consumption has already been made or that depreciation has already been deducted.
National and Domestic Concepts
The term national denotes that the aggregate under consideration represents the total income which accrues to the normal residents of a country due to their participation in world production during the current year.
It is also possible to measure the value of the total output or income originating within the specified geographical boundary of a country known as domestic territory. The resulting measure is called “domestic product”.
Market Prices and Factor Costs
The valuation of the national product at market prices indicates the total amount actually paid by the final buyers while the valuation of national product at factor cost is a measure of the total amount earned by the factors of production for their contribution to the final output.
GNP at market price = GNP at factor cost + indirect taxes – Subsidies.
NNP at market price = NNP at factor cost + indirect taxes – Subsidies
Gross National Product and Gross Domestic Product
For some purposes we need to find the total income generated from production within the territorial boundaries of an economy irrespective of whether it belongs to the inhabitants of that nation or not. Such an income is known as Gross Domestic Product (GDP) and found as:
GDP = GNP – Nnet Factor Income from Abroad
Net Factor Income from Abroad = Factor Income Received from Abroad – Factor Income Paid Abroad
Net National Product
The NNP is an alternative and closely related measure of the national income. It differs from GNP in only one respect. GNP is the sum of final products. It includes consumption of goods, gross investment, government expenditures on goods and services, and net exports.
GNP = NNP − Depreciation
NNP includes net private investment while GNP includes gross private domestic investment.
Personal Income
Personal income is calculated by subtracting from national income those types of incomes which are earned but not received and adding those types which are received but not currently earned.
Personal Income = NNP at Factor Cost − Undistributed Profits − Corporate Taxes + Transfer Payments
Disposable Income
Disposable income is the total income that actually remains with individuals to dispose off as they wish. It differs from personal income by the amount of direct taxes paid by individuals.
Disposable Income = Personal Income − Personal taxes
Value Added
The concept of value added is a useful device to find out the exact amount that is added at each stage of production to the value of the final product. Value added can be defined as the difference between the value of output produced by that firm and the total expenditure incurred by it on the materials and intermediate products purchased from other business firms.
Methods of Measuring National Income
Product Approach
In product approach, national income is measured as a flow of goods and services. Value of money for all final goods and services is produced in an economy during a year. Final goods are those goods which are directly consumed and not used in further production process. In our economy product approach benefits various sectors like forestry, agriculture, mining etc to estimate gross and net value.
Income Approach
In income approach, national income is measured as a flow of factor incomes. Income received by basic factors like labor, capital, land and entrepreneurship are summed up. This approach is also called as income distributed approach.
Expenditure Approach
This method is known as the final product method. In this method, national income is measured as a flow of expenditure incurred by the society in a particular year. The expenditures are classified as personal consumption expenditure, net domestic investment, government expenditure on goods and services and net foreign investment.
These three approaches to the measurement of national income yield identical results. They provide three alternative methods of measuring essentially the same magnitude.
The Income Method: adding factor incomes
Here GDP is the sum of the incomes earned through the production of goods and services. This is:
Gross Domestic product (by factor incomes) = Income from people in jobs and in self-employment + Profits of private sector businesses + Rent income from the ownership of land
Only those incomes that come from the production of goods and services are included in the calculation of GDP by the income approach. We exclude:
- Transfer payments e.g. the state pension; income support for families on low incomes; the Jobseekers’ Allowance for the unemployed and welfare assistance, such housing benefit.
- Private transfers of money from one individual to another.
- Income not registered with the Inland Revenue or Customs and Excise. Every year, billions of pounds worth of activity is not declared to the tax authorities.
This is known as the shadow economy or black economy.
Expenditure Method:
In this method, national income is measured as a flow of expenditure. GDP is sum-total of private consumption expenditure. Government consumption expenditure, gross capital formation (Government and private) and net exports (Export-Import).
GDP importance
Building Block of Macro-economic:
The Gross domestic product (GDP) number is the building block of macroeconomics. This is the case because modern day macro-economics is more or less about government making policies to help better the performance of the economy. Now, we are aware that the government extensively uses the GDP number to create policies and hence this number is the basis upon which many of our policies are made.
Identification of the Present State of Economy:
The official definition of the current state of the economy is based on the GDP number. For instance, recession is defined in terms of GDP number. If the GDP number records a fall for two consecutive quarters, we call it recession. On the other hand, if the GDP number records a decreasing rate of growth for two consecutive quarters, we call it a slowdown.
Hence, any economy officially identifies itself on the boom bust cycle based on the GDP number and so does the entire world.
Objective of policy formulation:
The Gross domestic product (GDP) number is not only the basis for diagnosing the problem with the economy. It is also useful in correcting it. Any government policy’s objective is measured in terms of the effect that it has on the GDP. For instance, if the GDP number is falling, the objective of the government policy would ideally be to reverse this position and create a situation where in the GDP number is rising. The government policy will define in clear quantifiable terms, what change they intend to bring to the GDP number. The success or failure of the government policy will be measured against this number that they have mentioned in their stated objectives.
Comparison between Economies:
The GDP number helps us make cardinal and ordinal comparison between economies. We can rank the economies of nations or regions by considering their GDP number. We can also draw conclusions about the relative size of the economy based on the GDP number. For instance, we can state that the economy of USA is 14 times larger than the economy of India. This statement really means that the GDP of USA is 14 times larger than the GDP of India.
The Root Cause!
Now, as we can see above that the GDP number is really the only thing that matters as far as macro-economic policy formation is concerned. Hence, the GDP number is of massive importance. Now, if this number was possibly defined wrongly or there were loopholes in the definition, it would allow for a massive misallocation of taxpayer resources and the policies that were created for a certain purpose could end up having the exact opposite effect.
This is the case today, if you believe many eminent economists. The people criticizing GDP are not some conspiracy theorists. Rather they belong to the realm of Nobel Prize winners and other mainstream economists. They believe that the wrong definition of GDP has a lot of unintended consequences. To a large extent, they attribute the recent economic crisis to the wrong decisions made as a result of this GDP misunderstanding.
GNP Importance
GNP is considered as an important economic indicator by economists and this data is used by them for finding solutions to the economic issues such as poverty and inflation.
When income is calculated on the basis of per person irrespective of the location, GNP becomes a much more reliable factor than GDP.
The information that is obtained from GNP is used for analysing the BoP (Balance of Payments). In some countries or unions such as European Union, economists use GNI or Gross National Income.
Drawbacks of GNP
- The foreign exchange rate fluctuates and therefore impacts the calculation.
- It does not help in knowing whether an economy is actually growing or shrinking.
