Measuring National Income
National income portrays itself as national product, national expenditure and national income, National Product, national expenditure and national income thus form a circular flow and make it possible to measure national income in three different ways, namely, as a sum of incomes derived from economic activities, as a sum of final expenditure on consumption and investment adjusted for imports and exports; or a sum of value added by the various producing sectors in the country adjusted for factor income payments to and from abroad, care must be taken with regard to the correction for depreciation of capital assets because the various elements in the aggregate are either ‘gross’ or ‘net’.
Since the measurement of national income through any of these approaches (methods) should yield identical results, they provide a cheek against each other. Provided double counting is avoided, it is possible to derive national income estimates partly by one and partly by other methods according to the availability of data.
Furthermore, the application of these different methods would provide analytical data on the functional relationship between the various groups and sectors of the economy, and the related subtotals render great help in formulating measures of economic policy. Each of these methods brings into lime-light different aspects of the basic operations of the economy, viz. production, distribution and consumption. A brief description of all these three methods of estimation is given below.
Three Methods of Measuring National Income
There are three approaches and methods of measuring national income
- Income Method
- Product Method
- Expenditure Method
1. Income Method of Measure National Income
Factors of production participate in economic activity to produce goods and services, the factors are compensated for the productive services rendered to the economy. This compensation or factor income payments takes the form of wages, profits, rent and interest.
Incomes generated by unduplicated production must equal the net value added at each stage of production. The production of bread, for Instance, has three stages i,e. entirely different from one another. First, the farmer produces the wheat and sells it to the floor mill. Second, the rifer turns it into flour and sells it to the baker. Third, the baker makes the bread and sells it to the final consumer. Mk: can either take the final price of the bread paid by the consumer and break it down into its component parts or take value added at each successive stage of production. In stage one, the value of wheat less cost, represents income to the farmer. In stage two, the value added by the millers equals the sale of flour less the cost of wheat, depreciation on equipment and other expenses. At stage three, the value added by the baker equals the sale price of bread less the value of flour etc. The value added at each stage can now be allocated to various factors of production. The incomes of the farmer, miller and baker represent: their profits, wages of their employees, rent of land and buildings, and interest on capital employed.
Thus, the same total can be reached by either summing up the value added at each stage of production or summing up all the factor incomes generated in the process of production.
2. Product Method of Measure National Income
The second approach to estimate national income consists of measuring the output of all producers and to deduct from this total the intermediate purchases. An unduplicated figure of this kind can be obtained separately for each producer. This represents the value of the intermediate products with which he starts and hence his contribution to the total value of production.
The sum of all final products measured at factor costs, net of ‘depreciation on fixed capital assets and corrected for income payments to and from abroad, would equal national income.
3. Expenditure Method of Measuring National Income
National income can also be measured as sum of expenditure on final goods and services less depreciation of capital assets. This involves drawing a distinction between final and intermediate purchases and transaction. In the above example, bread was a final product and its purchase by the consumer is a final transaction and hence a part of the final expenditure. The transaction between the farmer, miller and baker are intermediate transactions. As a broad rule, all purchases charged to current expense by business are treated as intermediate goods added to stock within the accounting period represent an addition to capital and though. They may not leave the business premises, expenditure on them will be a part of the final expenditure.
In other words, national expenditure in a closed economy is the sum of nation’s consumption and its investment. However, in an open economy having foreign trade, adjustments will have to be made for imports and exports. National expenditure is recorded at market prices. To derive estimates at factor costs, an adjustment has to be made for indirect taxes net of subsidies, if any.
Above, we have discussed the various methods of estimating of national income, whatever method may be used for the estimation of national income, double counting must be avoided.
Double counting means the counting of the value of goods and services at more than one stage i.e., at final and intermediate stages. In the example if bread, if the price paid by the consumer to the baker and the price paid by the miller to the farmer and that paid by the baker to the miller are all counted, it is “double counting”. Either the price paid by the final consumer to the baker or the value added at each stages i.e., the value of wheat, the value added by the miller and baker should be counted.