MEASUREMENT OF NATIONAL INCOME

In the previous chapter, we had studied some basic aggregates which help us
calculating national income. In this chapter we would actually calculate National Income of our
country by using different methods.
National Income refers to the factor income earned by normal residents ofa country as a
rewardof their productive services in the given year.
The national income ofthe country can be calculated by using 3methods;
1) Value Added Method
2) Income Method
3) Expenditure method
All the above 3methods give same value ofNational Income.
In India, 'Central Statistical Organization (CSO)' estimates national income.

1) Value Added Method:

This method is used to measure national income in different phases of production in
circular flow.
This method is also known as product method, inventory method, net output mnethod,
industrial origin method and commodity service method.
Every enterpriseadds to the value of the product which it purchases as intermediate
goods.The value that it added is known as Gross Value Added at Market Price
(GVAmp)
Value Added= Value of output - Intermediate consumption

Value added of all the producing enterprise within the domestic territory of a country
during a year is equal to GDPmp
Gross Value Added (GVAmp= GDPmp
ermediate Consumption:
efers tothe value of non-factor inputs( raw material. fuel, power etc) which are used in
process of production.
When domestic consumption is given
Intermediate consumption= Domestic consumption + Imports

alue of output(Sales):
refers to the market value of all the goods and services produced during a year.
alue of output- Sales {pricexQuantity+ Change in Stock( Closing stock-opening stock)}
When Domestic Sales is given
Value of Output=Domestic Sales +Change in stock + Exports

Steps to Calculate National Income through value Added Method:

1. Calculate ValueAdded of different Sectors:
Value Added= Value of Output-Intermediate Consumption
2. Calculate GVAmp:
The Value added of all the given sectors are added up to get Gross Value Added at
market price(GVAmp)
Also,
3. Calculate National
GVAmp-GDPmp
Income(NNPfc):
NNPfc= GDPmp-Depreciation+NFIA-NIT(indirect tax-subsidies)
Example to understand:
Suppose a farmer produces wheat and sell it for 500 rupees to a miller (value added by
the farmer),
Miller purchases wheat (for 500rupees) and
rupees converts it into flour and sold it for 700
It means that miller adds
200 rupees to the wheat
Finally the baker purchases it and sold it (value added by the farmer).
in the market for
consumer (which means he adds 300 1000 rupees to ultimate
Total value added =value rupees to the flour i.e. value added by the
baker added by farmer+ value added by miller+ baker)
Total value value added by
added=
500+200+300=1000
ECONOMICS ON YOUR TIPS -
rupees
 Value of Intermediate Value Added (value
Phases of Output
Production produced Output Consumption of output-Intermediate
(Sales price) (purchase price)| Consumption)
Phase 500
Wheat 0 500
1(farmer)
Phase 2
Flour 700 500 200
(Miller)
Phase 3
Baker 1000 700 300
(Baker)
GDPmp Gross value Added at market price(GVAmp)= 1000

. Precautions of value Added method:

Intermediate goods are not included(as national income included only final goods)
Saleand purchase of second hand goods are not included( however, any commission
orbrokerage on purchase or sale is included)
Domestic services are not included( housewife services, kitchen work etc)
Production for self consumption will be included.
Imputed value of owner occupied house should be included( as every house has
some rental value, no matter house is occupied by owner or rented out)
Whilecalculating national income (NNPfc) through Value added method the most important or general
problem is the problem of doublecounting.
i.e. Counting the samegood twice
Toavoid this problem,any of the given 2 methods must be adopted
1. Final Output method:
According to this method, value of only final goods should be added to determine the national income.
According to the above example, the final value is the amount at which the baker sells it to the
consumer that is rupees 1000. ultimate
So,GVAmp is 1000rupees (the value at which baker sells it to
the consumer)
2.Value added method:
According to this method, sum total of value added by each productive unit
should be taken to calculate
GVAmp.
According to the above example,
GVAmp-Value added by farmer+ Value added by millert value added by baker
GVAmp=500+200+300=1000rupees.
The important thing to keep in mind is
that, only one of the two mnethods
should
2) Income Method:
According to this method income received by all the residents of country for rendetin
their productive services (factor income) are added up to obtain National Income.
This method is also known as Distributive share method or Factor paymentmenod.
The sum total of all the factor income earned within the domestic territory of the country is
known as Domestic Income (NDPfc)

Components of Factor Income:

1. Compensation Of Employees(COE):
Itrefers to the amount paid to the employees for rendering their productive services.
It includes all the direct and indirect income received by the employees
It contains 3 elements:
Wages and Salaries in Cash.
Wages andSalaries in kind(example:- free flat, free petrolexpenses etc)
Employers Contribution to social security schemes( retirement pension etc)
2. Rent and Royalty:
Rent refers to the amount receivable by the landlord from tenant for use ofhis land.
Royalty is the income received for granting leasing rights ofsub-soil assets (payment for using
my name on their product)
3. Interest:
Itrefers to the amount receivedfor lending fundsto aproductive unit
(Interest on such loans which are given for some productive resources are included)
4. Profit:
It is the revward to an organization for his contribution in production ofgoods and services.
Profit earned by an enterprise is used for 3 purposes:
Corporate Tax( profit tax or business tax)
Dividend or distributed profit.
Retained earnings (undistributed profit, Reserve and Surplus, saving of private sector)
Profit-Corporate tax+ Dividend+ Retained earning
Rent
Income from
Property Royalty
Operating Surplus Income from Interest
entrepreneurship Profit
5. Mixed Income:
It refers to the income generated by own-account workers (like farmers, barbers etc) and
unincorporated enterprises (like retailers, small shopkeepers etc)
Mixed income arises from productive services of selfemployed persons.

Steps to Calculate NationalIncome from Income Method:

1.Estimate the factor income paid by each sector under the heads.
"Compensation to Enmployees(COE)
" Rent
"Royalty
" Interest
" Profit
"Mixed income

2. Calculate NDPfc:
The above factor income are added up to giveNDPfc
NDPfc

Mixed
COE Rent Royalty Interest Profit
Income
1. Calculate National Income(NNPfc):
NNPfc=NDPfc+NFIA

Precautionswhile calculating National income through income Method:

Transfer income willnot be included(as they are not connected with any productive
activities)
Sale and purchase of second hand goods are not included( however, any commission
or brokerage on purchase or sale is included)
Income from sale and purchase of share and bonds will not be included( as they does
not relate to any productive activity, however any commission or brokerage on such
transaction will be included)
Windfall gains will notbe included (like lotteries, income from horse race etc. As no
productive activity is involved)
Indirect taxX are not inluded(as the national income is at factor cost and Factor
cost-Market price-Net indirect tax)
 included.
outof past saving is not
Payment
Treatmentofillegalitems:
marketing=includedin national income( only costofproduction)
Smuggling, Black
production and services
of goods
As itcontains
Theft- Not included
goods is being taken)
As production doesn't happen (old the transaction is made with
wilIl be recorded in national income if
Jleoal activities
parties.
mutual agreement between the -
3 Expenditure method(Income disposable method):
According to this method, National income 1s measured in terms of expenditure made
services produced in the econom
by the consumers on purchase of final goods and
during an accounting year.
Market Price
The sum total of final expenditure is equal to Gross Domestic Product at
(GDPmp)
Components/Classification offinal expenditure:
1. Private Final Consumption Expenditure(PFCE):
It refers to the expenditure made by household or private institutions on purchase of
final goods and services produced within the country in an accounting year.
i.e. Expenditure on:
Durable goods(goods having long life)
Non durable goods(goods having very short life)
Services
2. Government FinalConsumption Expenditure(GFCE):
It refers to the expenditure made by general government on various administrative
services like Defence, law and order, education etc.
3. Gross Domestic Capital Formation(GDCF) or Gross Investment:
It refers to the expenditure incurred by the producer on final goods and services
produced within the domestic territory of thecountry for investment purpose.
It contains 2 components:
Gross Fixed capital formation:
Itrefers to the expenditure on purchase of fixedassets.
Inventory Investment:
Itrefers to the physical change in the stock of raw material.
Closing stock -Opening stock
 4.
Steps
GDPmp 2. 1. exports Net
3. Classify to
ulate PriceCalculate
(GDPmp)
Market GDPmp:
The calculate Exports:-Net
" " " and
Net Gross Private
above Government
Exports(Exports- the imports
onal 4 Domestic
expenditure final final National
final Exports=Exports-Importslt
consumption
consumption of
ConsumptionPrivate
Government Final Exports=Exports-Imports
income Netcountry a
fc): ExportsNet
orts-Imports) Consumption
Expenditure
Domestic
CapitalGross Final
Expenditure Capital
consumption
shouldbe
Imports)
Formation(GDCF) through duringa
Formation expenditure(PFCE) as
addedto
up
expenditure(GFCE) period
Expenditure
of
one
get refers
year.
Gross Method: to
(Closing-Opening) in CapitalGross
StockFormation
Change Fixed Domestic the
difference

Product
between
at
 calculating National income through expenditure method:
Precautions while
on intermediate goods will not be included
Expenditure includedin the value of final expenditure)
already
(as they are
Transfer income willnot be included
" included
Expenditure on second hand goods willnot be
" included
goods should be
" Commission on second hand
bonds is not included
" Expenditure on purchase of shares and
will be included
" Expenditure on own account production
(as they are already included)
EXPLANATION OF3 METHODS

Value Added method Income method

Expenditure Method
Calculation of GVAmp Compensation to Private final Consumption
Value Added(GVAmp)= employees Expenditure
Value of output +Rent +Govermment Final
Intermediate +Royalty Consumption Expenditure
consumption +Interest +Gross domestic capital
+Profit formation
+Mixed Income +Net Exports(Exports-Imports)

GDPmp NDPfc GDPmp

Reaching NNPfc Reaching NNPfc Reaching NNPfc

GDPmp NDPfc GDPmp
-Depreciation +NFIA -Depreciation
+NFIA +NFIA
-NIT -NIT

NATIONAL INCOME (NNPfc)

. National Income at current price and
constant price:
Natonal income at current price is the money value of goods and services produced in a yea
measured at the prices of currentyear.
It is also known as
It does not show the true condition of economic growth as, any
increase in Nominal National
Income could be due to increase in price.
National Income at constant price is the money value of goods and services produced na
year, measured at the constant price. i.e. at prices of baseyear
It is also known as Real National Income
Base year isa year which is free from price fluctuations.
It givesthereal picture of economic growth.

. Conversion ofNationalIncome at current price into Constant price:

It can be done with the help of Price Index
Price Index isan index number which shows the change in price levelbetween 2 different time
intervals
ncome at Current price
National Income at constant nricezNational
price=. x100
Current price Index

. Nominal and Real GDP(Gross Domestic Product):

Nominal GDP=GDP at current price
Real GDP=GDPat constant price
Real GDPisbetter than the nominal GDPas:
"Real GDP can be affected only by the change in physical output while the Nominal
GDP may increase due to increase in the level ofprice.
"Better measure to makeperiodic Comparison
"Facilitates international comparison.
GDP Deflector:
It measures the average level of prices of all the goods and services that makes up GDP
It is used to climinate the effect of price changes and to determine the real change in physical
output
Naminal GDP
GDP deflector x100
Real GDP

GDP andWelfare:
Generally.GDP presents the picture of the entire economicsystem of the economy. But, it is
not a satisfactory measure ofeconomic welfare.
GDP and welfare are not related to each other as:
1.Distribution ofGDP:
An increase in GDP may be due to increase in production of anyone sector
Itmay possible that improvement is not associated with economicwelfors

2.Change in Price:
di to increase in general
If the GDPof the country increases due price
change in physical output then, it will not bea reliable index of welfarelevel and not because atof

3.Non monetary exchanges:

It refers to those exchanges which are not meant
eant for money
services, helping an old man etc.
making purposes such as housewife
GDP does not include non monetary exchanges but it
influences the economic welfare.
4.Externalities:
It refers to the benefits and harms caused by the
firm or an individual for which they cant be
punished (such as pollution caused by the machinery etc) these
but had a great influence over the welfare ofthe economy. transactions does not affect GDP

5. Rate of Population growth:

GDP does not consider the changes in the rate
If therate of populationgrowth is higher than ofpopulation.
the rate of GDP then it will reduces the per capital
availability of goods and services which adversely affects the economic
welfare.
Green GNP(Gross National Product):
It measure the national income or output adjusted for the depletion of
degradation of environment natural resources and
"It leads to sustainable use of
natural resources.
"It resultsin greater
sustainability
"Itfacilitates equitable
distribution ofbenefits of development.
Topics Covered
Methods of calculating National
Value Added Method income(NNPfe):
"Income Method
"Expenditure Method