There are three
angles through which people perform economic activities, earn their living,
produce goods and services and distribute the national products.
(1)
The national economy is viewed as an aggregate of
producing units combining different sectors.
(2)
The entire national economy is considered as a
combination of individuals and households having several factors of production.
(3)
The national economy may also be viewed as an
aggregate of consumers, money savers and total investments.
Following
these approaches, national income measurement may be carried out through these
methods:
1.
Net Product method: considers the entire national economy as an
aggregate of producing units;
2.
Factor-income method: views national income as combination
of factor-owners and users.
3.
Expenditure method: treats national income as a collection of
spending units.
- Value Added Method or Net Output Approach
The
value added method consists of three stages:
- Determining the total value of domestic output in the various branches of production;
- Estimating the cost of inputs used as well the depreciation of physical assets; and
- Deducting the depreciation from gross value to obtain the net value of domestic output
The net
value of domestic output so obtained is often called the value added or income
produced equal to the total of wages, salaries, supplementary about incomes,
interest, profits, and net rent paid or accrued.
For
measuring the gross value of domestic product, output is divided under
different categories on the basis of the nature of activities from which they
originate. The classification of output
differs from country to country depending on the nature of domestic activities,
their significance in aggregate economic activities, and availability of required
data.
After
the classification of the output under the various categories, the value of
gross output is computed in two alternative ways:
- Multiplying the output of each category of sector by their respective market price and adding them together,
- Collecting data about the gross sales and changes in inventories from the account of the manufacturing enterprises and computing the value of GDP on the basis thereof
If there
are gaps in data, some estimates are made thereof and gaps are filled.
- Factor Income Method
Factor income method is also known as factor-share method. This
method calculates the national income by adding up all the ‘incomes accruing to
the basic factors of production used in producing the national product’. So the national income equals the sum of the
corresponding factor earning. Since there are broadly two factors of production
namely labour and capital, national income is supposed to originate from two primary
factors. Thus, the total factor-incomes are grouped under three categories
·
Labour income
·
Capital income and
·
Mixed income.
Labour incomes included in the national income are:
· Wages and salaries paid to the
residents of the country including bonus and commissions, and social security
payments,
· Supplementary labour incomes
including employer’s contribution to social security and employees’ welfare
fund, and direct pension payments to retired employees,
· Supplementary labour incomes in
kind such as free health and education, food and clothing, and accommodation.
Capital incomes include:
·
Dividends
·
Undistributed profits of
corporations,
·
Profit taxes,
·
Interest, rent,
·
Royalties,
·
Profits or surplus of
government enterprises.
Mixed incomes are a composite of:
·
Labour incomes,
·
Rent on own property,
·
Interest on own capital and
profits
·
Incomes in kind as farm
products consumed for the farm.
All the three kinds of income are added together to give the measure
of national income by factor income method.
- Expenditure Method
The expenditure method measures the
national income at the final expenditure stages. It has two variants:
·
The income disposal and
·
The product disposal
In the income disposal national
income or product is estimated from the expenditure of the three institutional
sectors:
·
Household,
·
Business and
·
Government
These sectors dispose of their
incomes either on consumption or on savings. Ex-posts, savings is synonymous
with investment or accumulation of capital stock.
Of the gross expenditures in the
economy by three sectors, only the expenditures on currently produced final
goods and services and net foreign investment are taken into account for
estimating national income. Expenditure on domestically transacted financial
assets on goods produced in preceding periods and second hand goods and on
intermediate consumption is excluded.
Expenditures of the three sectors
on currently produced final goods and services are classified broadly into:
·
Expenditure on consumption (C )
·
Expenditure on Investment (I)
Consumption is divided into:
·
Private consumption expenditure
and
·
The consumption by the
government sector
Similarly, investment is classified
into:
·
Private investment expenditure
and
·
Public sector investment
expenditure
Private investment includes capital
accumulation by the business sector, with the exception of new residential
dwellings constructed by the household sector, which is regarded as household
investment. In fact, residential construction is the only item of household
expenditure included under investment. All other household expenditures are
included under consumption, including those on consumer durables whether
actually consumed in the year or accumulated.
Gross national expenditure =
consumption expenditure+ gross national investment, where gross national
investment = gross domestic investment + net foreign investment.
Gross domestic investment =
replacement investment or depreciation + net domestic investment.
Hence, net national expenditure =
net domestic expenditure = consumption + net domestic investment + net foreign
investment.
However, national expenditure
measures the expenditure of residents of the country and net national product
or income the residents generated. If national expenditure exceeds national
income it means that the residents have received gifts from abroad in the form
of current and capital transfers from abroad. If national expenditure is less
than national income the residents have gifts to abroad.
In the product disposal variant,
national income or product is measured not from the point of view of income disposed
by residents but from the point of view of sales of production units in the
country. These domestic production units may sell either to residents or to
foreigners (exports or X).
However, residents’ expenditures on
consumption and investment may be on goods and services produced domestically
or on foreign goods and services (imports=M). Gross domestic expenditure on
goods and services = C + gross domestic investment +M. It follows then that
residents’ expenditure on the gross domestic product =C + I – M. And,
therefore, gross domestic product = sales to residents (C + I –M) plus sales to
foreigners or X). The gross national product = C + I + X – M+ net income from
abroad.
Choice of Methods
There are three common methods of estimating
the national income:
(i)
Net Product or Value Added
Method
(ii)
Factor-income Method
(iii)
Expenditure Method
All the three methods would give
the same measure of national income, subject to the availability of required data
for each method. Therefore, any of these methods may be used to estimate the
national income. But all the three methods are not appropriate for all the
economies since the requisite data may not be available. All the three methods
may not also be used for all purposes. Therefore, the question of choice of
method arises.
The choice of a particular method
may be made on the basis of two specific considerations:
1.
The purpose of national income
analysis, and
2.
Availability of necessary data.
i. For the purposes of analyzing
the net output or value added, the net output method is more appropriate than
the two other methods.
ii.
For the purposes of analyzing
the factor income distribution, income method is more appropriate.
iii. If the objective of the
national income estimation is to identify the expenditure pattern of the
national income, the expenditure or final product method should be adopted.
iv. However, availability of
adequate and appropriate data is a relatively more important consideration in
selecting a method of estimating national income.
In spite of the above, the most
commonly adopted method is the net product methods for the following reasons:
1.
Net product method requires
classification of the economic activities and output thereof that is much
easier than to classify income or expenditure, and
2.
The most common practice is to
collect and organize the national income data by the division of economic
activities.
No single method can provide an
adequate and accurate measure of national income since the statistical system
of no country provides the total data requirements for a particular method. Commonly,
therefore, two or more methods may be used to estimate the national income. The
combination of methods against is dependent on the nature of data required and
sector break-up of the available data.
Problems faced in the Measurement of National Income
There are a number of difficulties
in the measurement of national income of a country. The following are the
important problems in the measurement of national income.
1.
National income is always
measured in terms of money but there are certain goods and services whose
measurement in terms of money is not possible; for example, the services housewife
renders for her family, services performed voluntarily with charitable
objectives, hobby products, etc. Such
items are not possible to be included in the national income figures. This
causes an underestimate of the national income.
2.
Income generated through
illegal activities (such as black-marketing) is not included in the national
income. Their exclusion results in an under valuation of the national income.
3.
It is difficult to obtain
accurate statistics. This creates big differences between national income
statistics collected by different institution.
4.
The calculation of depreciation
on capital consumption presents another formidable difficulty. Since there are
no accepted standard rates of depreciation applicable to the different
categories of capital goods, the national income estimate will not be correct.
5.
It is not simple to avoid
double counting in the national income. To remove this difficulty final goods
and services are to be included in the national income, but this is also not an
easy job.
6.
The ups and downs in the prices
of goods and services also create problem in the estimation of national income.
In the same way, if general price index falls, the national income will also go
down, although national output may increase. Therefore, due to variations in
prices, it may be cumbersome to make an accurate estimate of national income.
7.
The transfer payment may also create
a problem in the estimate of national income. Whether interest on borrowings
and unemployment allowances be included in the national income causes an acute
problem.
8.
The prevalence of non-monetized
transactions in developing countries causes an important problem in the
measurement of national income. A considerable part of output does not reach the
market at all. A major part of agriculture output is consumed at the farm
itself. This decreases the national income estimate to a large extent.
National Income and Economic Welfare
National income or per capita
income is often considered as a measure of economic welfare. A man’s income is
the maximum amount he can consume during a week and still expect to be well-off
at the weekend as he was at the beginning. However, Gross National Product means
different things to different people.
Some understand it as a measure of economic welfare. However, GNP cannot
be used to measure subjective concepts that can be influenced by many factors
other than economic goods.
GNP
focuses on the production of goods and services makes no decision about how
useful the goods and services are or why people want goods and services. A dollar
spent on advertising counts as much as a dollar spent on a heart machine to
save life. GNP makes no distinction. The only criterion is whether or not
someone wants the ‘good’ or service. Of course, it is possible to develop a
measure of economic welfare but not of social progress. In measuring social
progress the problem is that most of the things we would like to measure do not
flow through market mechanism. Also the market prices of goods and services do
not shows how much customers value them.
Due
to different conceptual and practical issues associated with the estimation of
GNP one may raise doubts about the usefulness of the GNP measure particularly
when one is not able to equate increases in wealth with increases in welfare.
Factors such as the distribution of income may change our view of the standard
of living in a country. However, in
order to make an accurate evaluation of the standard of living of a country we
should take into consideration such aspects as the expectation of life, the
crime rate, the standard of health care, etc. Also producing more economic
goods, such as cars will also give rise to more economic ‘bads’ such as
pollution.
National income statistics may
mislead and may be deficient since they do not measure adequately welfare of a
nation. On the one hand such things as environmental pollution, the effects of
crime, and other dis-amenities are not deducted from output, on the other hand,
non-market activities as increases in leisure, advances in medical knowledge,
and the introduction of superior products are not included in the measurement
of output. These viewpoints identify the limitations of national income
accounting statistics. These statistics should not be used to measure welfare.
The most elaborate attempt to
develop a broader measure of economic well- being encompasses both the economic
‘goods’ and ‘bads’ generated during a specific period. It attempts to measure
‘consumption of things that provide utility to households rather total
production; it gives value to such non-marketed activities as leisure and makes
subtractions for each ‘disutilities’ as pollution and congestion. Of course,
subjective judgments are involved when researchers seek to place a value on
items that do not go through markets.
Recent years several have seen attempts
to develop alternative measures of national product that considers both the
unseen ‘pluses’ such as leisure and the ‘minuses’ such as pollution. Despite
all these problems GDP remains the simplest method to assess the level of
economic activity in a society.
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