## Note on Measurement of National Income and Its Difficulties

• Note
• Things to remember

## Methods of measurement of National Income or Product

There are three ways of calculating national income. They are income method, expenditure method, and product method. All these methods give the same result and any of these methods can be used in calculating national income. But the choice of particular depends on the available of data. The three methods of calculating national income are given below:

## 1. Product Method

Under this method, measurement of national income is calculated at the stage of production of goods and services during a year. Sometimes, there may be double calculation of same product if the calculation is done from the different stage of production. The product method includes the following two methods to avoid the double calculation problem:

## a) Final Product Method

To measure the national income from final product method, an economy is divided into different productive sectors like primary sectors (agriculture), secondary sectors (industry) and tertiary sectors (service). Finally, NI is calculated by adding the market value of all the goods and services produced in primary, secondary and tertiary sectors.

The components of final product method are as follows:

i. Primary Sectors: Agriculture is the primary sector. It includes various types of agro products like vegetables, fruits, crops, etc. Nepal has contributed around 31% of total GDP in primary sectors.

ii. Secondary Sectors:Industrial sector is kept in the secondary category. It includes activities of manufacturing and construction like food processing, iron and steel production, electricity, water supply, etc. Contribution of secondary sector in total GDP of Nepal is 14%.

iii. Tertiary sectors: Service sector is included in the tertiary sector. It includes banking, insurance, transport and communication, trade and commerce, etc.

The calculation of national income by product method is presented in table with hypothetical data:

Computation of NI by product Method:

 Production Sector Value of Product (in million) Primary Sector 10000 Secondary Sector 7000 Tertiary Sector 8000 Gross Domestic Product Net factor income 25000 -5000 Gross national product (GNP) Depreciation 20000 -1000 Net National Income (NNI) Indirect taxes Subsidies 19000 -1000 +2000 National Income 20000

The calculation of National Income by-product method includes various sectors like primary, secondary, tertiary and other production sectors which are measured in terms of million and calculated to get the national income.

Value added tax is more popular, advanced and scientific methord which helps to avoid the problem of double counting completely. Under the value-added method, NI is calculated by adding the value added amount in each stage of production. All the goods and services are produced being different stages of production. NI is the sum of the value added by different stages of producers in a country during the period of a year. We use the following formula to calculate the value added.

Value added = Sales value of output - Cost of intermediate goods

The calculation of National Income by value-added method is presented below:

 Production Stage Value of Output Cost of Intermediate Value Added Wheat (farmer) 20 0 20 Flour (flour mill) 50 20 30 Bread (baker) 70 50 20 Traders 80 70 10 Total 220 140 80

In the table, that there are four stages of production. A farmer produces wheat at equal to the value of Rs.20. Hence, Rs.20 is the value added to the economy. Flour mill grinds the wheat and sells flour to the bakery at Rs.50. Hence, the value added to the economy by the flour mill is Rs.50 and the net income added is Rs.30 (50-20). Similarly, the baker sells bread to the traders at Rs.70. Finally, the traders sell to the final consumers at Rs.80 and the net added is Rs.10 (80-70). Hence the sum of value added at each stage of the production is the final value and the final value is added to the National Income consumption.

## 2. Income Method

Income method measures the national income by adding all the incomes received by the owners of the factors of production in a year. Business organization uses various factors of production like land, labor, capital, organization, raw materials, etc to produce goods and services. The users of such resources make the payment of factors of production in the form of rent, wages, interest, profit, payments for raw materials. So, National income is the sum of incomes received by all these factors of production in a year.

The income approach includes the following components:

a) Wages and Salaries

It includes the wage and salary received by the employees during the year. It even includes the benefits as tips, bonus, etc.

b) Rent

Rent includes the rent of land, houses, factories, machinery, apartments, etc.

c) Interest

It is the additional amount paid by the borrower to the lender for the use of capital. It includes interest received.

d) Corporate Profits

It consists of corporate profits with inventory valuation and capital consumption adjustments.

e) Indirect taxes

The income generated from indirect taxes like VAT, sales tax, excise duty are also included in national income.

f) Net exports earnings

It is the difference between export earning and import expenses of goods and services.

The calculation of national income by income approach is presented in by the hypothetical table.

National income Accounting- Income Approach

 Income heading Amount of Income Wages and Salaries 5000 Rent 2000 Interest 3000 Corporate Profit 5000 Indirect taxes 1000 Gross Domestic Income (GDI) Net factor income from abroad 16000 +1000 Gross National Income (GNI) Depreciation 17000 -500 Net National Income (NNI) Indirect taxes Subsidies 16500 -500 1000 National Income 17000

From the above table, we get that wages and salaries are 5,000 million and rent is 2,000 million respectively. So like this way we get the different distribution of national income among the different class of people.

## 3. Expenditure Method

Another method of measurement of national income is expenditure method. Under this method, national income is calculated by adding the expenditure made by all the individuals or sectors of an economy. In an open economy, the demand for domestic output is made up of four components. It includes consumption expenditure made by household sector (C), investment expenditure made by household sector (I), government expenditure on goods and services (G) and net foreign export (X - M)

Under expenditure method, we calculate the GDP by using formula,

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

GNP = C + I + G + (X-M) + NFIA

NNP = C + I + G + (X-M) + NFIA - Depreciation

The components of expenditure method are as follows:

a) Consumption Expenditure (C)

Consumption is the major activities of the household sector. They consume different types of goods and services like basic goods (e.g. food, clothes, shelter), luxurious goods (e.g. gold, diamond), durable goods (e.g. TV, refrigerator), non-durable goods (e.g. fruits, vegetables) etc and services.

b) Private Investment Expenditure (I)

Investment is the prime responsibility of business sector. They invest a large amount of money in the production of goods and services. For eg: they invest in purchasing raw materials, technology plant and machinery, transportation, etc.

c) Government Expenditure (G)

Government invest large amount of money every year for the betterment of citizen (For e.g. government invest to run daily administration, to maintain law and order, infrastructure development like road, education, transport, etc.)

d) Net- Export (X - M)

Import and Export are two major components of international trade. The difference between export and import is called net-export. An open economy imports and exports a number of goods and services (like machinery, petroleum product, vehicle, etc.) It is also included in gross domestic expenditure.

Net factor which is received from foreign countries are also included in national income.

f) Depreciation

Depreciation expenditure of machinery equipments are also included in gross domestic expenditure.

The calculation of national income by expenditure method is shown in the following hypothetical table:

 Expenditure heading Expenditure Consumption expenditure 1000 Investment expenditure 2000 Government expenditure 3000 Net expenditure - 400 Gross Domestic Expenditure (GDE) Net income from abroad 2000 1000 Gross National Expenditure (GNE) Depreciation 3000 - 500 Net national expenditure (NNP) 2500

It is very difficult to collect the data on consumption and investment expenditure of millions of people, business firms and government in the estimation of national income by the expenditure method. Hence, this method is less practical and less useful.

#### Difficulties in the Measurement of National Income

There are many difficulties in measuring national income in our country accurately. Some of these difficulties involved in the measurement of national income are described below:

1) Non-Monetary Transaction

The first problem in national income accounting relates to the treatment of non-monetary transactions such as the services of housewives to the member of their families teaching their own child, working in own farm, fruits and vegetables produced and consumed by households, etc.

2) Problem of Double counting

Only final goods and services are included in the national income accounting. But it is very difficult to distinguish between final goods and intermediate goods. Intermediate goods may be used for final consumption.

Due to lack of required data on various economic activities, national income accounting has become quite a difficult task in developing countries. Even the available has become quite a reliable due to various factors such as geographical condition, etc.

4) Petty Production

There is a large number of petty production and it is difficult to include their production in national income because they do not maintain any account. Family members are engaged in the work and they should not maintain any account.

5) Transfer Payments

Individual gets a pension, unemployment, allowance and interest on public loans, but these payments create difficulty in the measurement of national income.

6) Environment damages

No nation prepares account related to the depletion of natural resources in terms of mining minerals, the erosion of soil, the pollution of air, water and soil and so on.

7) Second- hand Transaction

The transaction of second-hand goods only changes the ownership. They do not reflect additional production. They are excluded from national income because goods were included in national income when they were newly produced and sold first.

8) Illiteracy and Ignorance

If the majority of people are illiterate and ignorant, they cannot keep the records of production activities accurately. Hence, it is difficult to get the correct information about the production.

## Circular flow of income and expenditure:

Circular flow is the intergrated flow of goods and services among different sectors of economy. In other words, it is simple economic model illustrating flow of goods and services and money among different sector of economy.

In two sectors economic model, there is existence of only two sector household and business. Household sector supplies factors of production to the business secotr pay money for factor. Therefore, it represents both monitory real sector.

The circular flow of two sector economic model can be explained on the basis of following assumptions:

1. Existence of only two sector: household and business sectors.
2. All income should be spent on consumption and no saving.
3. There is no government sector and tax.
4. No foreign sector or no existence of export and import.
5. Factors of production are supplied by only household sector.

Reference:

Kanel, Navaraj et.al., Principles of Economics-XI, Buddha Prakashan, Kathmandu

Kharel, Khom Raj et.al., Economics In English Medium-XI, Sukunda Pustak Bhawan, Kathmandu

Methods of measurement of National Income or Product:

1. Income Method
2. Expenditure Method
3. Product Approach

Difficulties in measurement of the national income

1. Non-monetary transactions
2. Petty production
4. Problem of double accounting
5. Transfer payment
6. Environment damages
7. Second- hand Transaction
8. Illiteracy and Ignorance

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