14 – Calculation of National Income

Introduction

We can assess national income at the production stage by calculating the value of output, at the income accrual stage by calculating the amount of factor income obtained, or at the spending stage by calculating the total amount of expenditure incurred in the economy. The three different techniques of measuring national income are as follows:

1. Product Strategy

2. The Income Approach

3. Expenditure Methodology

14.1 Product Strategy

The sum of the net value of goods and services produced at market prices is calculated using this method. This approach involves three steps in calculating national income:

1. Gross product is computed by calculating the monetary value of output in various sectors of the economy.

2. The monetary worth of raw materials and services used, as well as the amount of depreciation of physical assets used in the manufacturing process, are totalled.

3. Determine the net output or value added by deducting the total cost of raw materials, services, and depreciation from the gross product determined in the first step.

Let us define the amounts of each of the three types of final outputs in a given year as Q₁, Q₂, Q₃………… Q_n and their respective market prices as P₁, P₂, P₃,………P_n, where n represents the total number of final products and services produced in the economy.

The magnitude of the national income (NI) will thus be equal to the sum of the annual flow of final commodities and services valued at their respective market values, according to the product method. In other words, NI = P₁Q₁ + P₂Q₂ + P₃Q₃ +……..+ P_nQ_n

The production technique entails estimating the gross value of a manufacturing unit’s goods, by-products, and ancillary activities and subtracting the value of raw material and other intermediates, including services, to obtain the gross value added.

In general, the steps are as follows:

1. Estimate the quantities of all outputs and inputs.

2. Obtain average price estimates for each output and input from market sources.

3. Using price-quantity data, compute the gross value of outputs and inputs and subtract the latter from the former to get the gross value added.

4. Calculate capital consumption by estimating the value of fixed asset stocks and applying predefined depreciation rates.

This method is used to calculate gross and net value added in the Indian economy’s following sectors:

-Agriculture and related activities (for example, animal husbandry)

-Forestry and logging

-Fishing

-Quarrying and mining

-Licensed Manufacturing

Obtaining trustworthy statistics on volumes and average prices for the first three of these sectors is challenging, especially for minor products and by-products, as well as for unorganised fishing activity. CSO relies on estimates derived from a range of sources, including the Union Ministry of Agriculture, state statistical bureaus, the Directorate of Market Intelligence, and others. The Annual Survey of Industries (ASI) provides data on inputs and outputs for registered manufacturers on a census basis for larger units and a sample basis for smaller units. However, ASI data is frequently out of date, necessitating many revisions. Corrections for non-response to ASI questionnaires must also be made. The Indian Bureau of Mines provides quantity and value statistics for inputs and outputs in mining and quarrying, which is supplemented by data from state governments.

The same approach can be used for constant price estimation, with prices from the base year being used for quantity valuation.

14.2 The Income Approach

This strategy is often referred to as the income-distributed method. The revenues earned by all of the basic components of production used in the production process are totalled using this method. Labour and capital are the two primary factors for calculating national income. We have three sources of income.

1. Wages, salaries, bonuses, social security, and welfare contributions are all examples of labour income.

2. Capital income, which includes dividends, pre-tax retained earnings, savings and bonus interest, rent, royalties, and government enterprise profits.

3. Mixed income, which includes earnings from professions, farming enterprises, and so on. The sum of these three income components yields national income.

National income can be calculated using the income technique by aggregating the annual flows of factor profits generated by the production of the final output. As a result, the value of output, say, excellent I (P_i Q_i), is reflected in the total of the equivalent factor incomes generated, i.e., P_iQ_i = R_i + W_i + I_i + P_i.

Where R_i, W_i, I_i, and Pi signify the flow of rent, wages, interest, and profits generated by the production of good I respectively. As a result, national income can be defined as the sum of the annual flow of various types of factor incomes in the economy.

Wages, salaries, rents, interest, and profits are directly aggregated together in this approach to produce estimates of value added. It is not essential to value output or input. This method is well suited to tasks whose output is difficult to quantify.

Services are a perfect example. However, credible statistics on factor incomes are only accessible for units that maintain proper annual accounts. For others, an indirect method must be used. One such method is estimating the number of workers employed as well as the value added per worker. The sum of the two yields an estimate of the overall value added in the relevant activity. Extrapolation-interpolation of decennial case numbers is used to estimate the number of workers; per worker value added is collected from surveys done at various times, with appropriate changes to bring the estimates up to date.

The method is used for the following tasks:

-Railways

-Power, gas, and water supply

-Transportation, Storage, and Communication

-Banking, Finance, and Insurance

-Property

-Administration and defence

Annual accounts provide nearly complete data for the first three groupings. Such information is also available for a portion of the latter three, namely the organised sector. The indirect approach must be used for the remainder.

Unorganised sectors of the economy, such as unregistered manufacturing, trade, hotels and restaurants, and a range of personal services, have the most limited database coverage. For these industries, preliminary estimations are employed, sometimes based on a production approach and sometimes on an income approach. Estimates are frequently acquired for a benchmark year in which a significant survey was done, and these benchmark estimates are then brought up to date using a variety of indicators.

Constant price estimates utilising the income approach are derived by updating the base year estimates with physical indicators such as the quantity of power sold, the number of tonne-kilometres of freight travel, and so on.

14.3 Expenditure Methodology

This is referred to as the ultimate product procedure. The total national expenditure, according to this method, is the sum of the expenditures incurred by society in a given year. Personal consumer spending, net domestic investment, government expenditure on goods and services, and net foreign investment are the four types of expenditures (imports and exports).

The flow of total spending can be calculated by adding the flows of expenditure on final products and services incurred by the three major sectors involved, namely the household sector, the business sector, and the government sector. Thus, according to the expenditure approach, national income can be calculated as NI = E_h + E_b + E_g.

Where E_h, E_b, and E_g signify the annual flow of expenditure on final goods and services incurred by the home, business, and government sectors, respectively.

These three methods of calculating national income get identical results. They offer three different ways of measuring essentially the same magnitude. If we take the product or expenditure approach, we are attempting to calculate national income by the size of the income flow in the upper half of the circle. In contrast, if we use the income approach, we are attempting to estimate the flow in the lower half of the circle.

14.4 Issues with Measuring National Income

The major issues that impede the computation of national income using a specific method have already been examined, as have the methods. Now, let’s talk about the challenges that arise in general.

The following are the issues in calculating national income:

1. National income is a measure of domestic economic performance rather than social well-being. There should be a substantial positive link between the two in order for true economic growth to occur.

2. National Income understates social welfare since non-market transactions such as homemaker services and do-it-yourself initiatives are not included.

3. National Income does not account for changes in leisure or job satisfaction, as well as changes in product quality.

4. National income does not fully reflect environmental changes such as oil spills. Cleanup is counted as a positive output, while additional pollution is not counted as a negative.

5. Per capita income is a more accurate indicator of living standards than total national income.

6. There is a duplicate counting issue. The value-added technique, on the other hand, could avoid the problem of double counting. For example, wheat, which is used to produce bread, is classified as an “intermediate good.” The value of bread is only counted as part of GNP; we do not include the value of wheat supplied to the miller or flour sold to the baker.

7. Depreciation estimation issues, as there are various ways of computing or estimating depreciation.

8. The inclusion or omission of specific items in national income accounting might lead to confusion.

a. Imputed rent from owner-occupied residences is also factored into the national income computation.

b. The value of goods and services produced for personal consumption is included.

c. The sale and acquisition of used items is prohibited.

d. Imputed rent of owner-occupied residences and self-consumption production are included.

e. Income from illicit activity is excluded.

f. Direct taxes, such as income tax, that employees pay with their salaries are included.

g. Expenses incurred in the purchase of an old share are not deductible.

h. Government spending on all transfer payments is not included.

9. Difficulties in obtaining information, particularly those relating to the underground economy (illegal activities).

14.5 Circular Flow of Income

The circular flow of income model depicts the movement of revenue between producers and households that purchase their goods or services. Income flows from households to producers as households buy products or services, while income flows from producers to households as wages or profits. Let’s look at the circular flow of revenue in a two-sector model and a four-sector model.

14.5.1 Income Circular Flow in a Two-Sector Model

One of the most fundamental realisations about the aggregate economy is that it is a cyclic flow in which output and input are interdependent. Household income is comprised of household expenditures (consumption and saving) and company expenditures (wages, rents, and so on).

 

 

 

 

 

 

 

 

 

 

 

 

 

 

A model that depicts the flow of revenue across an economy is the circular flow of income model. Displaying leakages in the economy and injections reveals the various factors affecting economic activity. Just like a leak in a bucket reduces the amount of water in the bucket, a leak in the economy reduces economic activity. And, just as an injection into a bucket causes the water level to rise, an injection into an economy causes economic activity to rise.

The Fundamental Assumptions of a Simple Circular Flow of Income Model

1. The economy is divided into two sectors: households and businesses.

2. Households spend their entire income (Y) on products and services (C). There is no hope (S).

3. Households purchase all output (O) created by enterprises through their expenditure (E).

4. There is no financial industry.

5. There is no public sector.

6. There is no international sector.

The state of equilibrium in the simple two-sector circular flow of income model is described as a scenario in which there is no tendency for the levels of income (Y), expenditure (E), and output (O) to fluctuate, that is, Y = E = O.

This means that all household income (Y) is spent (E) on company output (O), which is equal in value to payments made by companies to households for productive resources.

As an illustration, consider the fact that if John earns $100, he does not save any of it and instead spends it entirely on the products and services (O) offered by the businesses.

2 Sector Model with Financial Market

Financial institutions operate as go-betweens for savers and investors. All lending and borrowing takes place in the financial or capital markets. Households don’t spend all of their income on consumption; some of it instead goes towards saving. Savings are deposited in the financial market, resulting in a money flow from the home to the financial market. On the other hand, the company saves to cover depreciation and expansion costs. The firm’s savings in the financial market and its borrowings from the financial market create money flows.

As a result, we might say that family and firm savings are leakages, while firm borrowings act as injections into the circular flow of income.

 

 

 

 

 

 

 

 

 

 

 

 

 

14.5.2 Income Circular Flow in a Three-Sector Model

In this model, we also include the government sector, which buys commodities from enterprises and factors services from families. When the government makes transfer payments to households, money transfers from the government to the households. Such as old-age pensions, scholarships, and household factor payments. When the government collects direct taxes from households, money comes back to the government.

Similarly, money moves between the government and private sectors. When the government collects corporate taxes from the firms, money transfers from the firms to the government. Subsidies and payments for items purchased are examples of how money moves from the government to firms.

 

 

 

 

 

 

 

 

 

 

 

 

 

14.5.3 Income Circular Flow in a Four-Sector Model

In a four-sector model, an economy transitions from a closed to an open economy. Imports and exports occur in an open economy. You must comprehend that one country’s exports are the imports of another. When a country imports, money moves to the rest of the world; when a country exports, money flows in from the rest of the world. A trade surplus occurs when an economy’s exports surpass its imports. On the other hand, a trade deficit exists when imports surpass exports. Imports act as leaks, while exports act as injections into an economy’s circular flow of income.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

We have, in a four-sector model,

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

Where,

Y = Earnings or Output

C = Consumption spending in the home

G = Government Expenditure

I = Investment Expenditure

G = Government Expenditure

X – M = Exports minus Imports