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National economy is also viewed as a collection of consuming, saving and investing units
(individuals, households and government).
The above notions of a national economy helps to measure National Income by following
three different methods:
1.
2.
Factor-income method
3.
Expenditure method
Multiplying the output of each category of output factor by their respective market price
and adding them together.
2.
Collecting data regarding the gross sales and changes in inventories from the account of
the manufacturing firms to compute the value of GDP. If there are gaps in data then some
estimates are made to fill the gaps.
added together. The total thus obtained is taken to be the measure of net national products or
national income by product method.
3. Deduction of these costs and depreciation from gross value to obtain the net value of
domestic product:Net value of domestic product is often called the value added or income
product. Income product is equal to the sum of wages, salaries, supplementary labor incomes,
interest, profits, and net rent paid or accrued.
2. Factor-Income Method
This method is also known as income method and factor-share method. Factor income method
is used when national economy is considered as a combination of factor-owners and users.
Under this method, the national income is calculated by adding up all the incomes accruing to
the basic factors of production used in producing the national product. Factors of production
are classified as land, labor, capital and organisation. Accordingly,
National income = Rent + Wages + Interest + Profits
However, it is conceptually very difficult in a modern economy to make a distinction between
earnings from land and capital and between the earnings from ordinary labor and
organisational efforts including entrepreneurship. Therefore, for estimating national income
factors of production are broadly grouped as labor and capital. Accordingly, national income is
supposed to originate from two primary factors, viz., labor and capital. However, in some
activities, labor and capital are jointly supplied and it is difficult to separate labor and capital
from the total earnings of the supplier. Such incomes are termed as mixed incomes. Thus, the
total factor-incomes are grouped under three categories:
1.
Labor incomes
2.
Capital income
3.
Mixed incomes.
Labor Income: Labor incomes included in the national income have five components:
1.
Wages and salaries paid to the residents of the country including bonus, commission
and social security payments.
2.
3.
Supplementary labor incomes in kind such as free health, education, food, clothing and
accommodation.
4.
Compensations in kind in the form of domestic services and other free of cost services
provided to the employees are included in labor income.
5.
Bonuses, pensions, service grants are not included in labor income as they are regarded
as transfer payments. Certain other categories of income such as incomes from incidental
jobs, gratuities and tips are ignored because of non-availability of data.
2.
3.
Interests on bonds, mortgages and savings deposits (excluding interests on bonds and
on consumer credit)
4.
Interests earned by insurance companies and credited to the insurance policy reserves
5.
6.
Net rents from land and buildings including imputed net rents on owner occupied
dwellings
7.
Royalties
8.
The data for the first two incomes is obtained from the firms accounts submitted for taxation
purposes. There exist difference in definition of profit for national accounting purposes and
taxation purposes. Therefore, it is necessary to make some adjustments in the income-tax data
for obtaining these incomes. The income-tax data adjustments generally pertain to (i) Excessive
allowance of depreciation made by tax authorities, (ii) Elimination of capital gains and losses
since these do not reflect the changes in current income, and (iii) Elimination of under and
overvaluation of inventories on book-value.
Mixed Income: Mixed incomes include income from (a) farming (b) sole proprietorship (c) other
professions such as legal and medical practices, consultancy services, trading and transporting.
Mixed income also includes incomes of those who earn their living through various sources
such as wages, rent on own propertyand interest on own capital.
All the three kinds of incomes, viz., labor incomes, capital incomes and mixed incomes added
together give the measure of national income by factor income method.
3. Expenditure Method
The expenditure method, is also known as final product method. This method is used when
national economy is viewed as a collection of spending units. It measures national income at
the final expenditure stages. In other words, this method measures final expenditure on GDP
at market prices at the stage of disposal of GDP during an accounting year. In estimating the
total national expenditure, any of the following two methods are followed:
First method: Under this method all the expenditure factors are computed and added
up to arrive at total national expenditure. The items of expenditure which are taken into
account under the first method are (a) Private consumption expenditure, (b) Direct tax
payments, (c) Payment to the non-profit-making institutions and charitable organisations
like schools, hospitals and orphanage, and (d) Private savings.
Second Method: Under this method the value of all the products finally disposed of are
computed and added up to arrive at the total national expenditure. Under the second
method, the following items are considered (a) Private consumer goods and services,
(b) Private investment goods, (c) Public goods and services and, (d) Net investments from
aboard. This method is extensively used because the requisite data required by this method
can be collected with greater ease and accuracy.
deducted from the value of national output to arrive at the approximate measure of national
income.
2.
If the objective is to analyse the net output, then the net output method would be more
suitable. In case, objective is to analyse the factor-income distribution then, suitable method
would be factor income method. If objective at hand is to find out the expenditure pattern of
the national income then the expenditure method is more suitable. However, availability of
adequate and appropriate data is relatively more important considerations in selecting a
method of estimating national income.
However, the most common method is the net output method because of the following
reasons:
The most common practice is to collect and organize the national income data by the
division of economic activities. Therefore, easy availability of data on economic activities is
the main reason for the popularity of the output method.
However, it should he borne in mind that no single method can give an accurate measure of
national income. This is because no countrys statistical system provides the total data
requirements for a particular method. The usual practice is therefore, to combine two or more
methods to measure the national income. The combination of methods again depends on the
nature of required data and the sectoral breakdown of the available data.