Methods of estimating National Income

In this method, a country’s national income can be calculated by adding the output of all the firms in the economy to determine the nation’s output.

Product method is also known as output method or value added method. In this method, we calculate the national income in terms of final goods and services produced in an economy during a particular period of time. The final goods are those which are either available to the consumers for consumption or become a part of national wealth in the form of investment.

Product method is that which estimates the national income by measuring the contribution of final output and services by each producing enterprise in the domestic territory of a country during a given accounting period.

Classification of Productive Enterprises

The first step in this method of measuring national income is the classification of enterprises. All the productive enterprises in the economy are classified into three main categories, viz. (i) Primary Sector, (ii) Secondary Sector and (iii) Tertiary Sector. Let us briefly explain these sectors.

• Primary Sector – Primary sector refers to that sector of the economy which exploits natural resources to produce goods. Agriculture and allied activities like mining, quarrying, fishing, forestry etc. are included in this sector.
• Secondary Sector – The manufacturing sector of the economy which transforms one physical good into another is included in the secondary sector.
• Tertiary Sector – The tertiary sector of the economy, generally known as the service sector consists of the provision of services instead of end products

Classification of Output

National output is classified into the following types:

• Consumer Goods – Consumer goods are those goods which help in the further production of consumer gods. These are also called are also called capital goods.
• Producer Goods– Producer goods are those goods which help in the further production of consumer goods. These are also called capital goods.
• Govt. Produced Goods– These include defence, police, education, health care, roads, railways, ports, dams etc.
• Net Exports– Net exports refer to the value of goods and services exported to the rest of the world minus the value of goods & services imported during an accounting year.

Measurement of Value of Output

There are two methods of measuring the value of output. They are (i) Final output method, (ii) Value added method. Below we discuss these two approaches of product method of measuring national income.

(i) Final Output Method

In final method, we have to estimate the following element involved to arrive at the correct figure of the final output.

(a) Value of output

Here output means final goods as well as intermediate goods. The value of all these goods can be estimated by multiplying the quantity of output of each producing unit with the market price. This is equal to the value of sales and the change in stock.

(b) Value of intermediate consumption

The goods and services used by the firms as inputs are known as intermediate consumption. To calculate the value of intermediate consumption, we have to multiply the intermediate goods with the prices paid by the enterprises to purchase these goods.

(c) Consumption of fixed capital

Consumption of fixed capital means depreciation. When goods are produced, there is wear and tear of machines leading to the loss of value of the capital assets. To calculate this loss of value in an accounting period, we have to deduct the value of capital asset at the end of the period from the value of the asset at the beginning of the period.

According to final output method, the value of intermediate goods is deducted from the value of output. The quantity produced by each producing enterprise is multiplied by the market price. This gives us the value of output. From this, we deduct the value of intermediate consumption to arrive at the value of the output.

Value of final output= Value of output- Value of intermediate goods

When we add the market value of final output in the primary sector, secondary sector and that of tertiary sector, we arrive at gross domestic product at market price.

GDP at Market Price = Market value of final output of primary sector + Market value of final output of tertiary sector

By deducting depreciation from GDP at market price we can get net domestic product at market price. When we add net factor income from abroad, we get GNP and NNP at market price.

Expenditure method: In this method, the national income is calculated by adding all the expenditures that are done for purchasing the national output.

• The expenditure method is a system for calculating gross domestic product (GDP) that combines consumption, investment, government spending, and net exports. It is the most common way to estimate GDP. It says everything that the private sector, including consumers and private firms, and government spend within the borders of a particular country, must add up to the total value of all finished goods and services produced over a certain period of time. This method produces nominal GDP, which must then be adjusted for inflation to result in the real GDP.
• Expenditure is a reference to spending. In economics, another term for consumer spending is demand. The total spending, or demand, in the economy is known as aggregate demand. This is why the GDP formula is actually the same as the formula for calculating aggregate demand; because of this, aggregate demand and expenditure GDP must fall or rise in tandem
• However, this similarity isn’t technically always present in the real world—especially when looking at GDP over the long run. Short-run aggregate demand only measures total output for a single nominal price level, or the average of current prices across the entire spectrum of goods and services produced in the economy. Aggregate demand only equals GDP in the long run after adjusting for price level.
• The expenditure method is the most widely used approach for estimating GDP, which is a measure of the economy’s output produced within a country’s borders irrespective of who owns the means to production. The GDP under this method is calculated by summing up all of the expenditures made on final goods and services. There are four main aggregate expenditures that go into calculating GDP: consumption by households, investment by businesses, government spending on goods and services, and net exports, which are equal to exports minus imports of goods and services.
• There are four factors of production: natural resources or land; human resources or labour; produced means of production or capital; and entrepreneurs or organisation.
• The payment for the use of land is called rent. Payment for the use of labour is known as wages and payment for the use of capital is known as interest. The factors of production — land, labour and capital are primary factors of production and their contractual payments are called factor incomes. The surplus—what is left after the payment of these primary factors — is called the profit. This residual income is paid to the organiser of production as profit.
• Thus, income for the participation in the production process may take four forms: rent, wages, interest and profit. By national income we mean the sum-total of all rent, wages, interest and profit earned in the production process during a given period by all the citizens, which is known as the factor payments total.

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. Thus, national income is calculated by adding up factor incomes generated by all the producing units located within the domestic economy during a period of account.

The resulting total is called Domestic Income or Net Domestic Product at FC (NDPFC)- By adding net factor income from abroad to domestic income, we get National Income (NNPFC)- Mind, in income method national income is measured at the stage when factor incomes are paid out by enterprises to owners of factors of production—land, labour, capital and enterprise.

Since net value added by an enterprise is the result of services of factors of production, therefore, the same is distributed in the form of money income (rent, wages, interest, etc.) among factors of production. Hence, value of national income method should be the same as the one calculated by value added method.

Following are the main steps involved in estimating national income by income method:

• Identify enterprises which employ factors of production (land, labour, capital and enterprise).
• Classify factor payments into various categories like rent, wages, interest, profit and mixed income (or classify factor payments into compensation of employees, mixed income and operating surplus).
• Estimate amount of factor payments made by each enterprise.
• Sum up all factor payments made within domestic territory to get Domestic Income (NDP at FC).
• Estimate net factor income from abroad which is added to Domestic Income to derive National Income.
• Only factor incomes which are earned by rendering productive services are included. All types of transfer income like old-age pension, unemployment allowance, etc. are excluded.
• Sale and purchase of second-hand goods are excluded since they are not part of production of current year but commission paid on sale of second-hand goods is included as it is reward for rendering productive services. Likewise, sale proceeds of shares and bonds are not included.
• Imputed rent of owner occupied dwellings and value of production for self-consumption is included but value of self-consumed services like those of housewife is not Included.
• Income from illegal activities like smuggling, black-marketing, etc. as well as windfall gains (e.g., from lotteries) are excluded.
• Direct taxes such as income tax which are paid by the employees from their salaries and corporate tax, which is paid by the joint stock company from its profit, are included. But wealth tax and gift tax are excluded since they are deemed to be paid from past savings and wealth. Similarly, indirect taxes like sales tax, excise duties, which tend to increase market prices, are not included.