METHODS OF MEASUREMENT OF NATIONAL INCOME

Corresponding to the three phases of circular flow of income of a country i.e. production,
income and expenditure, national income of a country can be measured in three ways:
a) As a flow of goods and services produced i.e. net output method/ net value added/
product method
b) As a flow of income generated i.e. income method
c) As a flow of expenditure of goods and services i.e. expenditure method
PRODUCT METHOD
This method has two approaches a) Final output method, wherein only final goods and
services are counted and all intermediate consumptions are ignored b) the value added
method, wherein only the value added by each productive enterprise at different stages of
production is included and summed up.
The following steps are involved in the product method a) classification of producing unit
b) estimation of net value added c) calculation of net factor income from abroad

a ) Classification of Producing Units

All production units in an economy are generally classified into three broad industrial
sector on the basis of nature of production process.
I ) Primary Sector : This includes all those production units which are related to the
exploitation of natural resources like fishing, farming, mining etc
II ) Secondary Sector : This sector transforms goods from one form to another. It includes
large scale and small scale industries
III) Tertiary Sector : This sector provides various types of services to the primary and
secondary sector like banking, insurance , transport communication etc

b) Estimation of Net Value added:

The second step involves calculation of value of output, consumption of intermediate
goods and depreciation of capital goods. It involves 1) estimation of gross output
produced by each enterprise 2) estimation of intermediate consumption 3) estimation of
depreciation 4) estimation of net indirect taxes
The estimation of gross output by each enterprise can be done by multiplying its
production by appropriate market prices. It is called gross because it is computed without
deducting the depreciation and cost of intermediate goods. To obtain net value added at
market price we deduct 2) and 3) from 1). Now if we deduct net indirect taxes from net
value added at market price we get net value added at factor cost. The sum of net value
added of all industrial enterprises within the domestic territory of the country we get net
domestic product at factor cost ( NDP at factor cost )
Value added = Value of output (-) cost of intermediate goods (-) net indirect taxes
C ) Estimation of net income from abroad:
The final step is to estimate the net income earned from abroad and add it to the domestic
product so as to get national income.
Thus NNP at factor cost = Net Domestic product at factor cost + net factor income from
abroad.
We have to include the following items
1) Own account production of fixed assets like residential buildings, corporate
enterprises and government enterprises
2) Production of food and other items of self consumption
3) Imputed rent of owner occupied houses
But certain items are not included in the estimation of national income
1) Sale and purchase of second hand goods
2) Sale and purchase of bonds and shares
3) Services of housewives

INCOME METHOD
This method measures from the payments aspect as payments are made by producing
units to primary factors of production such as land, labour, capital and enterprise. It can
be defined as the sum total of factor incomes earned by the normal residents of a
country during a year by working both within or outside the territory of the country.
In other words it is a sum total of factor payments received by the normal residents of the
country. This mode of calculating national income involves the following steps
1) Identification and classification of producing units: In the first stage producing
units which employ factor services are identified. These are classified as primary,
secondary and tertiary sectors. This includes various industrial groups such as
agriculture, mining , manufacturing, electricity, transport, communication etc.
2) Classification of Factor Income: The factor incomes are grouped under the
following three broad categories: a) Compensation of employees : This is defined
as payments made by the producers to the employees in he form of their wages,
salaries and other payments such as bonus, commission, employers contribution
to social security etc. in return of their services b) Capital or Property Income
( Operating surplus ) : It is the income paid for the ownership and control of
capital. Capital Income includes dividend , undistributed corporate profits,
corporation taxes, interest, rent , royalties and profits of the government. C)
Mixed Income : It is composed of labour income and capita income of those
people who provide both labour and capital services. Such incomes include
earnings from agriculture, trading, transport, sole proprietorship, professions like
legal, medical and income of own account workers.
3) Estimation of Factor Income : In the third stage income received by factor units in
various producing enterprises is summed up as the total of factor payments of all
three kinds of incomes i.e. compensation of employees, capital income and mixed
income. Thus we get the income generated by the enterprises within the domestic
territory of the country which is called Net Domestic Product at factor cost or
Domestic Factor Income.

Domestic Factor Income = Compensation of employees + capital Income + Mixed

income
4) Net Factor Income from abroad: In the last stage net factor income earned from
abroad is added to the domestic factor income to arrive at National Income. NFIA
is the difference between income received from other countries for the factor
services rendered and the income paid to the non-residents for rendering services
in the domestic territory of the country
National Income = Domestic Factor Income + Net Factor Income from Abroad
While calculating national income by income method we should include the following
items ; 1) Value of production for self consumption, such as agricultural products used by
the farmers for the consumption of their families 2) Imputed rent of houses occupied of
the owners of these houses.
The following items should not be included in national income 1) All transfer incomes
are excluded from national income such as pension, government subsidies, scholarship
etc 2) Illegal income like income of gamblers, smugglers as they are not accountable 3)
corporation taxes have to be excluded as they are part of corporate profits which are
already included in factor income 4) Interest on national debt is excluded 5 ) income
received from sale of purchase of second hand goods, bonds and shares are excluded
from national income .
Income method of estimating national income is useful because it provides information
about the distribution of national income among the various factor categories.
EXPENDITURE METHOD
In this method national income is measured at the disposition stage. It estimates national
income by aggregating all final expenditure on gross domestic product at market price in
an accounting year. Under this method the economy is divided into four groups 1)
Household sector 2) Government sector 3) Producer sector 4) Rest of the world.
Steps involved in the estimation of national income are :

1) Classification of final expenditure : This expenditure is divided into four

categories a) Private Final Consumption Expenditure It comprises expenditure
by the residential household and other institutions like schools, clubs on consumer
goods and services b) Gross domestic capital formation It is the expenditure on
capital goods and services undertaken by the producers. It is also known as
investment sector c) Government final consumption expenditure. It consists of
expenditure of the government on administrative services, defence expenditure,
expenditure on maintenance of law and order etc. d) Net exports of goods and
services Expenditures are incurred by the residents of other countries on goods
and services produced in the domestic territory of a country. These expenditures
are exports of goods and services. Similarly, a country imports goods and services
from other countries. All these expenditures on import of goods and services are
imports from the side of the purchasers but they are part of domestic product of
another country. It is the difference between the value of exports and value of
imports during a year which is known as net exports. Net exports are part of
expenditure on GDP.
2) Estimation of Final Expenditure : To get the estimate of gross final expenditure
we take the final expenditure of different components of the economy as given
below: a) Estimation of private final consumption expenditure We calculate the
final consumption by the households on the domestically produced consumer
goods and services by multiplying the volume of sales in the market with retail
prices. Production of self consumption is calculated at prevailing market prices. b)
Estimation of Government Final Consumption Expenditure It is valued in terms
of cost to the government as a sum total of compensation on the employees and
cost of goods and services purchased by the government to provide these
services.c) Estimation of Gross Domestic Capital formation It consists of
expenditure on construction , machinery, equipment and changes in inventory.
Expenditure on construction, machinery, equipment and changes in inventory give
us the total expenditure on gross domestic capital formation. d) Net Exports
finally the value of net exports i.e. difference between the value of exports and
imports of goods and services, is estimated.

Now if we add private final consumption expenditure, government final

consumption expenditure, gross domestic capital formation and net exports, we
will get Gross Domestic Product at market price. By deducting depreciation and
net indirect taxes from it we get NDP at factor cost and finally by adding net
factor income from abroad we get NNP at factor cost or National Income.
NY = C + Ig + G + (X-M) D NIT + NYA
Where NY = national income; C = private consumption expenditure; Ig = gross
investment expenditure; G is government expenditure; X is exports; M is imports;
D is depreciation; NIT is net indirect taxes; NYA is net factor income from
abroad.
Precautions : 1) All expenditure on second hand goods is to be excluded 2)
expenditure on financial assets like shares and bonds within the country is to be
excluded 3) all government expenditure on transfer payments should be excluded
for expenditure on all intermediate goods and services is also excluded
Conclusions: The expenditure method provides information about the level of
consumption and investment in the economy. It also shows relative contribution
of the private sector and the public sector to the consumption and investment in
the economy.
Is tax a transfer payment?
Yes tax is transfer payment bacause the citizens of the country pay tax to the
government without getting any goods or srevice in return (no quid pro quo).Its a
unilateral payment.
Difference between current transfer and capital transfer.
a) Current transfer is from present income of the consumer and
capital transfer is from past income.
b) In current transfer ,it is usually done for meeting present
consumption expenditure of the receiver whereas capital transfer
is for the purpose of capital formation of the receiver.
c) Example of current transfer ; scholarship,pensions
Example of capital transfer : Economic aid,war indemnities

Difference between Income payment and transfer payment

Income payment

Transfer payment

Bilateral in nature

Unilateral payment

Payment made in return of service

Payment made without any expectation of return

Included in NI as it adds to prod.

Excluded frm NI as it does not add to production

Distinguish between Net Exports and NFIA

1) Net export is the difference between exports and imports whereas NFIA is the
difference between factor income received from abroad and factor income paid to
non-residents for rendering productive service within the domestic territory of the
country.
2) Net exports includes only non factor income services (insurance,banking etc)and
material goods whereas NFIA includes only factor services.
3) Net export is part of domestic product whereas NFIA is not part of domestic.