13_MEASUREMENT OF NATIONAL INCOME class 12

ECONOMICS (CLASS-XII)

Chapter-13

Measurement of National Income

Method

There are three methods of measuring national income.

Value added method is defined as the difference between total value of output of a and the value of inputs bought from other firms.

Value added Þ Value of output – Intermediate consumption

Value of Output

Value of output of an enterprise is the quantity produced by it during a year multiplied by the per unit market price. Sales includes sales within and outside the country.

Value of output = Sale + Change in stock

Change in stock = Closing stock – Opening stock

Steps

following are the steps to calculate national income by product method —

Step-I :Identification and classification of producing enterprises

Producing enterprises are identified and classified into primary, secondary and tertiary sector.

1. Primary sector : It includes all the agricultural and allied activities eg. fishing, mining. It produce goods by exploring natural resources.
2. Secondary sector : This sector is also known as “manufacturing sector”. It converts one type of a commodity into another. Eg.Manufacturing of cotton cloth from cotton yawn.
3. Tertiary sector : This sector is also known as service sector. It provides useful services to the primary and secondary sector of an economy.

STEP II :Calculation of NVAFC of each producing enterprises

(a)      Value of output is calculated by multiplying the amount of goods and services of each enterprise with the respective market prices and adding change in stock.

Value of output = Sales + Change in stock

(b)      Intermediate consumption is estimated by using the price paid by each enterprise. It is deducted from value of output to obtain GVAMF.

GVAMP = Value of output – Intermediate consumption

(c)      The value of depreciation and NIT (indirect taxes and subsidies) is estimated and deducted from GVAj^p to calculate NVAFC.

NVAFC = GVAmp- Depreciation – NIT

STEP III: NDPFC is calculated

NVAFC of all the producing sector is added to calculate NDPFC or domestic income.

STEP IV :NNPFC (National Income) is calculated

National income is calculated by adding net factor income from abroad to domesticincome.

NNPFC = NDPFC + NFIA

Precaution to be taken :

(1)      The sale and purchase of second hand goods should not be included in national income.

(2)      The value retained for self consumption should be included.

• Imputed value of owner — occupied house should be included.
• Own — account production of fixed capital by household, firms and govt, should be included.
• Domestic services are not included in national income. But the value of paid employees must be included.

(6)      Leisure is not included in national income because its valuation is negligible.

INCOMEMETHOD

According to income method, national income is measured in terms of the payment made to different factors of production (i.e. land, labour, capital and entrepreneur) for their productive services. Since, factor income is the cost of employers, so factors income and factor cost is the same.

Following are the steps to calculate national income by income method –

STEP I :Identification and classification of producing enterprises

Inthis method, all the production units that employ factor inputs is identified i.e. primary, secondary and tertiary sector.

STEP II: Classification of factor income

Factor income generated in the production unit are classified into the following categories-

• Compensation of employees.
• Operating surplus Rent, Royality, Interest and Profit)
• Mixedincome of self employed.

STEP III: Estimation of domestic factor income (NDPFC)

Factor income paid by each producing unit mentioned above are added to obtain NDPFC.

NDP­FC = Compensation of employees + Operating surplus

+ Mixed income of self employed

STEP IV : Estimation of National Income

To calculate national income, NFIA (net factor income from abroad is added to domestic factor income (NDPFC).

NNPFC = NDPFC + NFIA

Precautions to be taken :

• Transfer earnings such as indirect taxes; old age pensions, scholarships should not be included and as there are unilateral payments.
• Illegal income through the activities like smuggling, black marketing are not included in the national income as these are difficult to calculate.
• Imputed value of services of the owner of production unit are to be included eg. Rent of owner occupied houses on the basis of prevailing market rent.
• Income from the sale of second hand goods should not be included as no new production has taken place in the current year.
• Income arising from the sale of financial assets like shares, debentures should not be included in national income because there is no increase in the production.
• Income form windfall goings like lotteries are not included as it is not earned by providing anything. It is a transfer concept.

NET DOMESTIC PRODUCT AT FACTOR COST

Net domestic product at factor cost can be defined as total factor income earned by the factor of production while working within the domestic territory of the country in an  accounting year.

The main components are :

• Compensation of employees : Compensation of employees refers to all the payments & transfers made by employers to their employees (both in cash and kind! in lieu of their productive services.

It includes the following —

• Wages and salaries
• Employer’s contribution to the social security scheme
• Private pension and payment of pension to retired persons.

(2)      Operating Surplus : It is the total income earned by the firm during the process of production from property and entrepreneurship.

(i)       Income from property: Income from property refers to the income occurring from the ownership of the financial assets (bonds debentures) real assets (land, mines, forest etc.) and intangible assets (patents, copyright). Therefore, income from property is classified as

(ii)     Rent: It is the income earned by the owner of the land, building, machinery and other properties.

• Interest :Interest is a payment for providing capital to the production unit.
• Royality:Royality is the payment made for the use of natural resources (i.e. mining) or granting the right for using patents, copyrights & trademarks etc.

(v)      Income from entrepreneurship : The income earned by the entrepreneurs from the entrepreneurship is called Profits. However, profit is divided in 3 parts:

1. Dividend
2. Corporate Tax (tax on company’s profit)
3. Reserves
4. Mixed income of the self employed: It is the 3 component of the domestic factor income. It is the income which has the features of both COE and OS e.g. lawyer’s fees or doctor’s fees.

Expenditure Method

Private Final Consumption Expenditure is the money value of final goods and services purchased by the resident households including non – profit institutions. It includes the consumption of

• Durable goods
• Non-Durable goods

(3)      Services

Private Consumption Expenditure

It includes

• Household’s final consumption expenditure + Private non-profit institutions serving households final consumption expenditure.
• It includes expenditure incurred by the normal residents whether in the domestic territory or abroad.

Investment (Gross Domestic Capital Formation)

It is the addition to the capital stock of an economy in the given time period. It is also known as capital formation. It is undertaken by both private and govt. The various components are —

• Business fixed investment : It includes all the addition to the capital stock made by business houses. Eg.plant& machinery, tools &equipments. It is undertaken with the objective of increasing the productive capacity of the business.
• Inventory Investment or Change in Stock: Inventory Investment is measured by change in stock. Change in stock is closing stock less opening stock.
• Residential Construction Investment: It is the amount that is spent on the construction of new residence by the households.
• Public Investment : It includes the capital formation undertaken by govt. eg. Construction of flyovers, hospitals etc.

Government Purchases of Goods and Services

It includes all the purchases made by the govt, to provide welfare services to the economy eg. schools, hospitals. Transfer payments made by the government are not included.

Government Final Consumption Expenditure

• It is equal to the cost of goods and services produced by the government for collective use by the public. It is calculated at the cost as it is sold to the public without profit.

Intermediate consumption of government + COE paid by the Government + Direct purchases from abroad for embassies and consulates located abroad – sale of goods and services produced by government.

Net Exports – Exports – Imports

It is also known as Consumption method and income disposable method. National income is estimated by aggregating all the final exp. in an economy duringa year.

The expenditure in an economy can take two forms —

• It can either be consumed by households and general govt. i.e. final consumption expenditure.
• Or used to produce assets i.e. Capital formation.

Step Involved

STEP I: To identity economic units incurring final expenditure

Various economic units which incur final expenditure are –
(a) Household Sector                (b) Production Sector

(c) Govt. Sector                        (d) Rest of the World

STEP II: Classification of final expenditure

The final expenditure are

• Private final consumption expenditure by households and non – profit institutions serving households.
• Gross investment i.e. Exp. on acquiring goods for enhancing the production

2. Inventory investment
3. Public investment
4. Residential investment

• Govt, final consumption exp. i.e. equals to the value of all the goods provided by govt.
• Net Exports (Exports – Imports)

The sum total of above exp. provide us with GDPMP

STEP III: Calculate national income

To calculate national income from GDPMP, depreciation and NIT are subtracted and NFIA is added to it.

NNPFC = GDPmp– DEP – NIT+ NFIA

Precautions to be taken :

• Expenditure on only final goods and services should be taken and not the exp. on intermediate goods as it will lead to the problem of double counting.
• Expenditure on the payment made on the second hand goods should not be included as these are not the part of current year output.
• Output that is self-consumed or own account production on that may be for consumption or investment should be included in national income.

Expenditure on financial assets like shares debentures should be excluded because they reflect the transfer of ownership. However brokerage or commission should be included.