Methods of measuring national income – Labour Income, Capital income – StudyMaterial

Economics

Methods of Measuring National Income

All goods and services produced in the country must be counted and converted against money value during a year. Thus, whatever is produced is either used for consumption or for saving. Thus, national output can be computed at any of three levels, viz., production, income and expenditure.

Accordingly, there are three methods that are used to measure national income.

1. Production or value added method

2. Income method or factor earning method

3. Expenditure method.

1.Product Method:

Product method measures the output of the country. It is also called inventory method. Under this method, the gross value of output from different sectors like agriculture, industry, trade and commerce, etc., is obtained for the entire economy during a year.

The value obtained is actually the GNP at market prices. Care must be taken to avoid double counting. The value of the final product is derived by the summation of all the values added in the productive process. To avoid double counting, either the value of the final output should be taken into the estimate of GNP or the sum of values added should be taken.

In India, the gross value of the farm output is obtained as follows :

1. Product Method Product method measures the output of the country. It is also called inventory method. Under this method, the gross value of output from different sectors like agriculture, industry, trade and commerce, etc., is obtained for the entire economy during a year. The value obtained is actually the GNP at market prices. Care must be taken to avoid double counting.

The value of the final product is derived by the summation of all the values added in the productive process. To avoid double counting, either the value of the final output should be taken into 12-Economics-Chapter_2.indd 23

(i) Total production of 64 agriculture commodities is estimated. The output of each crop is measured by multiplying the area sown by the average yield per hectare.

(ii) The total output of each commodity is valued at market prices.

(iii) The aggregate value of total output of these 64 commodities is taken to measure the gross value of agricultural output.

(iv) The net value of the agricultural output is measured by making deductions for the cost of seed, manures and fertilisers, market charges, repairs and depreciation from the gross value.

Similarly, the gross values of the output of animal husbandry, forestry, fishery, mining and factory establishments are obtained by multiplying their estimates of total production with market prices. Net value of the output in these sectors is derived by making deductions for cost of materials used in the process of production and depreciation allowances, etc. from gross value of output.

Net value of each sector measured in this way indicates the net contribution of the sector to the national income.

Precautions

The product method is followed in the underdeveloped countries, but it is less reliable because the margin of error in this method is large.

In India, this method is applied to agriculture, mining and manufacturing, including handicrafts.

1. Double counting is to be avoided under value added method. Any commodity which is either raw material or intermediate good for the final production should not be included. For example, value of cotton enters value of yarn as cost, and value of yarn in cloth and that of cloth in garments. At every stage value added only should be calculated.

2. The value of output used for self consumption should be counted while measuring national income.

3. In the case of durable goods, sale and purchase of second hand goods (for example pre owned cars) should not be included.

National Income:

Income Method (Factor Earning Method) This method approaches national income from the distribution side. Under this method, national income is calculated by adding up all the incomes generated in the course of producing national product.

Steps involved

1. The enterprises are classified into various industrial groups.

2. Factor incomes are grouped under labour income, capital income and mixed income.

i) Labour income – Wages and salaries, fringe benefits, employer’s contribution to social security.

ii) Capital income – Profit, interest, dividend and royalty

iii) Mixed income – Farming, sole proprietorship and other professions.

3. National income is calculated as domestic factor income plus net factor incomes from abroad.

In short, Y = w + r + i + π + (R-P) w = wages, r = rent, i = interest, π = profits, R = Exports and P = Imports

This method is adopted for estimating the contributions of the remaining sectors, viz., small enterprises, banking and insurance, commerce and transport, professions, liberal arts and domestic service, public authorities, house property and foreign sector transitions.

Data on income from abroad (the rest of the world sector or foreign sector) are obtained from the account of the balance of payments of the country.

Precautions

While estimating national income through income method, the following precautions should be taken. Items not to be included

1. Transfer payments are not to be included in estimation of national income as these payments are not received for any services provided in the current year such as pension, social insurance etc.

2. The receipts from the sale of second hand goods should not be treated as part of national income as they do not create new flow of goods or services in the current year.

3. Windfall gains such as lotteries are also not to be included as they do not represent receipts from any current productive activity.

4. Corporate profit tax should not be separately included as it has been already included as a part of company profit. Items to be included

1. Imputed value of rent for self occupied houses or offices is to be included.

2. Imputed value of services provided by owners of production units (family labour) is to be included.

Items to be included

1. Imputed value of rent for self occupied houses or offices is to be included.

2. Imputed value of services provided by owners of production units (family labour) is to be included.

3. The Expenditure Method (Outlay method) Under this method, the total expenditure incurred by the society in a particular year is added together.

To calculate the expenditure of a society, it includes personal consumption expenditure, net domestic investment, government expenditure on consumption as well as capital goods and net exports.

Symbolically,

GNP = C + I + G + (X-M) C – Private consumption expenditure I – Private Investment Expenditure G – Government expenditure X-M = Net exports Precautions

1. Second hand goods: The expenditure made on second hand goods should not be included.

2. Purchase of shares and bonds : Expenditures on purchase of old shares and bonds in the secondary market should not be included.

3. Transfer payments : Expenditures towards payment incurred by the government like old age pension should not be included.

4. Expenditure on intermediate goods :

Expenditure on seeds and fertilizers by farmers, cotton and yarn by textile industries are not to be included to avoid double counting.

Factor cost

*(FC)There are a number of inputs that are included into a production process when producing goods and services.

*These inputs are commonly known as factors of production and include things such as land, labour, capital and entrepreneurship.

*Producers of goods and services incur a cost for using these factors of production.

*These costs are ultimately added onto the price of the product.The factor cost refer to the cost of production that is incurred by a firm when producing goods and services.

*Examples of such production costs include the cost of renting machines, purchasing machinery and land, paying salaries and wages, cost of obtaining capital, and the profit margins that are added by the entrepreneur.

*The factor cost does not include the taxes that are paid to the government since taxes are not directly involved in the production process and, therefore, are not part of the direct production cost.

*However, subsidies received are included in the factor cost as subsidies are direct inputs into the production.

Market price

(MP)Once goods and services are produced they are sold in a market place at a set market price.

The market price is the price that consumers will pay for the product when they purchase it from the sellers.

Taxes charged by the government will be added onto the factor price while subsides provided will be reduced from the factor price to arrive at the market price.

Taxes are added on because taxes are costs that increase the price, and subsidies are reduced because subsidies are already included in the factor cost, and cannot be double counted when market price is calculated.

Thus,

MP = FC + Indirect Taxes – Subsidies

Or, FC = MP – Indirect Taxes + Subsidies

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