LESSON 3 NY ACCOUNTING

Measurement of National Income

There are three different methods to measure national income. There are three main
ways of calculating these numbers; the Output or Product method, the Income method
and the Expenditure method. In theory, the three must yield the same, because total
expenditures on goods and services (GNE) must equal the total income paid to the
producers, and that must also equal the total value of the output of goods and services
(GNP).
I.

The Product Method:

National income may be defined as the aggregate money value of the net annual flow
of final goods and services in the national income. In the Product Method, the value
of the total sum of all final goods produced in the economy is taken to estimate NY.
Only final goods and services are included in national income i.e. final consumption
and stocks of raw material and capital goods. All intermediate goods and services are
excluded from this estimation. For example, raw material used in production, energy,
etc. are excluded. Otherwise it leads to the problem of double counting.
Double Counting: Suppose that to make bread, 1 Kg of wheat is needed. The price of
wheat is Rs.10. The wheat has to be converted into flour, and the price of 1 Kg of
flour is Rs.12. The cost of bread is Rs. 15. If we include the cost of wheat + flour +
bread = 10 + 12 + 15 = Rs.37. This is the problem of double counting, because wheat
and flour are intermediate goods, and are included in the price of bread. If the price of
only the final good bread is taken, the true value of output will be = Rs. 15.
Alternatively, the Value Added Method is used to estimate NY without double
counting. Thus the initial price of wheat is Rs. 10, Value added by making into flour
is Rs.2 (12 10), and value added in making into bread is Rs. 3 (15 12). The value
added method will give the price as 10 + 2 + 3 = Rs.15. The error of double counting
can thus be avoided.
Capital loss and gain: This definition also excludes incomes generated by capital
gains (and losses). This is because national income is only the flow of final goods
and services. Capital gains do not flow from the production of any good or service.
Hence they are excluded from national income. This means that incomes from a rise
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in the value of assets such as land, equity etc. are not included in national income.
Final goods also include goods that are used to replace old machinery, spare parts etc.
So value of depreciation is included in this method, and the NY figure will be of
gross income.
Many final goods and services do not bear a market price because they are not
marketed. These include the services of housewives to the family, production for self
consumption by farmers, a large part of animal husbandry, dairy and poultry, the
produce of kitchen gardens, services of children to their parents, etc. The value of
self-consumed goods, self occupied houses, etc. has to be imputed and added to the
NY figure.
Since this method uses only the value of goods produced within the country, it does
not include income earned from abroad. So, net factor incomes from abroad are not
included in NY figure.
The Product Method thus gives GDP at market prices, since the value of all goods is
taken at the market price.
II. The Income Method:
The Income Method estimates NY by aggregating factor incomes of a nation. The
main types of income that are included in this measurement are Rent (the money paid
to owners of land), Salaries and Wages (the money paid to workers who are involved
in the production process, and those who provide the natural resources), Interest (the
money paid for the use of man-made resources, such as machines used in production),
and Profit (the money gained by the entrepreneur - the businessman who combines
these resources to produce a good or service). Incomes of Indians living abroad are
also included in this estimation.
This gives NY at factor cost. The Factor Income definition suffers from the
disadvantage of not explaining why only factor incomes are taken in national income
instead of all personal incomes.
The equation for measurement of National Income by Income Method:
NDP at factor cost = compensation of employees + operating surplus + mixed
income of self employee
National income = NDP at factor cost + NFIA (net factor income from abroad)

III. The Expenditure Method:

The Expenditure Approach is the most popular national output accounting method. It
focuses on finding the total output of a nation by finding the total amount of money
spent. This too is acceptable, because like income, the total value of all goods is equal
to the total amount of money spent on goods. The basic formula for domestic output
combines all the different areas in which money is spent within the region, and then
combining them to find the total output.
GDP = C + I + G + (X - M)
Where:
C = Household consumption expenditures
I = Gross private domestic investment
G = Government consumption and gross investment expenditures
X = Gross exports of goods and services
M = Gross imports of goods and services

I. Multiple Choice questions:

1. The product method of measuring NY excludes which of the following:
a. Factor incomes from abroad
b. Depreciation
c. Double counting
d. (a & c)

2. In the Income Method, the NY figure arrived at is:

a. GNP at factor cost
b. GDP at market prices
c. NY at market prices
d. NY at factor cost

3. Which of the following incomes is excluded in the Income method of NY

computation?
[ ]
a. Contribution of housewives
b. Scholarships
c. Pension payments
d. (b & c)
4. The Expenditure Method of computing NY includes which of the following? [
a. Value of self consumed goods
b. Net exports
c. Net Investment
d. (a & c)

II. Fill in the Blanks:

1. GDP includes the value of only the ______________ goods and services produced
within the country.
2. NDP = GDP minus _________________
3. Welfare payments and social security payments are also known as _____________
payments.

4. Net exports are defined as ______________ minus ______________.

5. Real GNP is equal to ________________ GNP divided by the Price Index.
III. Short answers:
1. Definition of National Income.
2. Value Added Method
3. Government Deficits
4. Capital gains
5. Non-marketed goods