Term Paper on Methods of Measuring the National Income

INTRODUCTION
Meaning:
It is defined as, the value of all the final goods and services produced by the normal residents of a country, whether operating within the domestic territory of the country or outside, in a year. It is the money value of all the final goods and services produces by a country during a period of one year. National income consists of a collection of different types of goods and services of different types. Since these goods are measured in different physical units it is not possible to add them together. Thus, there is no way except to reduce them to a common measure. This common measure is money.

Dept. of MBA, PESIT

2012-2013

Term Paper on Methods of Measuring the National Income

NEED FOR THE STUDY OF NATIONAL INCOME

The study of the national income helps in the following ways: To measure the size of the economy and level of countrys economic performance. To trace the trend or speed of the economic growth in relation to previous year(s) as well as to other countries. To know the structure and composition of the national income in terms of various sectors and the periodical variations in them. To make projection about the future development trend of the economy. To help the government to formulate suitable development plans and policies to increase growth rates. To fix various development targets for different sectors of economy on the basis of their performance. To help business firms in forecasting future demand for their products. To make international comparison of peoples living standards.

Dept. of MBA, PESIT

2012-2013

Term Paper on Methods of Measuring the National Income

BASIC CONCEPTS IN NATIONAL INCOME

Gross domestic product
It is the money value of all final goods and services produces in the domestic territory of a country during an accounting year. It can be estimated at current prices and at constant prices. If the domestic product is estimated on the basis of the prevailing prices it is called Gross Domestic Product at Current Prices. If GDP is measured on the basis of some fixed price, that is price prevailing at a point of time or in some base year it is known as Gross Domestic Product at Constant Price or Real Gross Domestic Product. The contribution of each producing unit to the current flow of goods and services is known as the net value added. GDP at Factor Cost is estimated as the sum of net value added by the different producing units and the consumption of fixed capital. Conceptually, the value of GDP whether estimated at factor cost or market price must be identical. This is because the final value of goods and services must be equal for the cost involved in their production. GDP = Consumption + Government Expenditures + Investment + Exports Imports

Net domestic product

While calculating GDP no provision is made for depreciation allowance. In such a situation GDP will not reveal the complete flow of goods and services through various sectors. A part of it is therefore set aside in the form of depreciation allowance. When depreciation allowance is subtracted from GDP we get Net Domestic Product. NDP = GDP Depreciation

Dept. of MBA, PESIT

2012-2013

Term Paper on Methods of Measuring the National Income

Gross National Product

It is defined as the sum of the gross domestic product and the net factor incomes from abroad. Thus, in order to estimate the gross national product of India we have to add net factor income from abroad i.e., income earned by non-resident in India to form the GDP of India. GNP = GDP + NFIA

Net National Product

It can be derived by subtracting depreciation allowance from GNP. It can also be found out by adding the net factor income from abroad to the net domestic product. NNP = GNP Depreciation If the net factor income from abroad is positive then NNP will b more than NDP. If the net factor income from abroad is negative then NNP will be less than NDP and it would be equal when the net factor income from abroad is zero. NNP = NDP + NFIA

Dept. of MBA, PESIT

2012-2013

Term Paper on Methods of Measuring the National Income

METHODS OF MEASURING THE NATIONAL INCOME

Primarily there are three methods of measuring national income. Which method is to be employed depends on the availability of data and purpose. The methods are: Product Method Income Method Expenditure Method Product method is given by Dr. Alfred Marshall, income method by A.C. Pigou and expenditure method by Dr. Irving Fisher. According to product method, the total value of final goods and services produced in a country during a year is calculated at market prices. According to this method only the final goods and services are included and the intermediary goods and services are not taken into account. According to income method, the net income payments received by all citizens of a country in a particular year are added up. The net incomes earned by the factors of production in the form of rent, wage, interest and profit aggregated but incomes in the form of transfer payments are not included in the national income. According to the expenditure method, the total expenditure incurred by the society in a particular year is added together. There expenditures include personal consumption expenditure, net domestic investment, government, expenditure on goods and-services, and net foreign investments, government, expenditure and net foreign investment. According to these methods total expenditure equals the national income. The choice of above three methods depends on the level at which the national income is calculated. The product method is the principal method used in underdeveloped economies, whereas income method is generally used in developed economics for the estimation of national income.

Dept. of MBA, PESIT

2012-2013

Term Paper on Methods of Measuring the National Income

PRODUCT METHOD
In this method, national income is measured as a flow of goods and services. We calculate money value of all final goods and services produced in an economy during a year. Final goods here refer to those goods which are directly consumed and not used in further production process. Goods which are further used in production process are called intermediate goods. In the value of final goods, value of intermediate goods is already included therefore we do not count value of intermediate goods in national income otherwise there will be double counting of value of goods. To avoid the problem of double counting we can use the value-addition method in which not the whole value of a commodity but value-addition (i.e. value of final good value of intermediate good) at each stage of production is calculated and these are summed up to arrive at GDP. The formula for computation by this method is given by:

O=C+I
Where, O stands for output C stands for consumption of goods I stands for investment goods

Dept. of MBA, PESIT

2012-2013

Term Paper on Methods of Measuring the National Income

INCOME METHOD
Under this method, national income is measured as a flow of factor incomes. There are generally four factors of production labour, capital, land and entrepreneurship. Labour gets wages and salaries, capital gets interest, land gets rent and entrepreneurship gets profit as their remuneration. Besides, there are some self-employed persons who employ their own labour and capital such as doctors, advocates, CAs, etc. Their income is called mixed income. The sum-total of all these factor incomes is called NDP at factor costs. According to this method Net incomes of individuals and business houses during a year are added to know the national income. Only those incomes earned and received for producing goods and for rendering services are to be counted. Transfer payments such as old age pensions, widow pensions and unemployment benefits etc should not be counted as these are the incomes received without contributing to the production. The formula for computation by this method is given by:

Y=C+S
Where, Y stands for Total Income C stands for consumption S stands for Savings

Dept. of MBA, PESIT

2012-2013

Term Paper on Methods of Measuring the National Income

EXPENDITURE METHOD
In this method, national income is measured as a flow of expenditure. GDP is sum-total of private consumption expenditure. Government consumption expenditure, gross capital formation (Government and private) and net exports (Export-Import). One mans income is another mans expenditure. Therefore national income can be arrived at by adding the total expenditure of individual and business firms during a year. Expenditure or outlay on final products takes place in three ways: Expenditure by consumers on goods and services Expenditure by entrepreneurs on capital or investment goods Expenditure by government on consumption and capital goods

Y=C+I
Where, Y stands for total expenditure C stands for consumption expenditure I stands for investment expenditure

Dept. of MBA, PESIT

2012-2013

Term Paper on Methods of Measuring the National Income

Comparison of the Three Methods:

The Product method is very suitable for primary sector such as agriculture industries etc. The income method is suitable for service sectors. The Expenditure method is only for the calculation of identical relationship between three methods. It is because we may not get the details of all the expenditure correctly.

Dept. of MBA, PESIT

2012-2013

Term Paper on Methods of Measuring the National Income

PROBLEMS IN ESTIMATING THE NATIONAL INCOME

Measurement of national income poses several difficulties, which include both conceptual and statistical ones. They are briefly described below: 1. National income consists of not one but innumerable goods, service, and they have to be somehow added up to arrive at a measure of national income. The real difficulty arises from the fact that dissimilar things cannot be added up. They have to be converted into some common denominator before doing so and the only practical way of doing so is to take their market prices. Now it is widely recognized that market prices do not represent the true social valuation of the goods and services. In the case of officially determined prices, they reflect only what the authorities decide them to be and in the case of market determined prices, all kinds of market imperfections distort them. The market prices are deeply influenced by: (i) The market structure. (ii) The sales and marketing campaigns of the suppliers. (iii) Taxation, subsidies and other rules, regulations and restrictions of the authorities. (iv) The prices of productive resources and distribution of income and wealth. (v) The role of speculative forces. (vi) Shifts in prices of imports and exports. In other words, we do not have a reliable method of adding flows of diverse goods and services. 2. The problems of addition increase manifold when we consider the question of estimating national income in real terms. All the problems faced in the compilation of price index numbers are encountered in this case. 3. There are also serious problems regarding the reliability of information to be used in estimating national income. They include the following:

Dept. of MBA, PESIT

2012-2013

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Term Paper on Methods of Measuring the National Income

(a) Several pieces of information are available with undue delay and it is not possible to use them in time for formulation of effective policy measures. At the most, this information may be used to revise the past estimates. (b) A modern economy is so complex that it is next to impossible to gather complete information needed for estimates of national income. A number of intelligent guesses have to be made and used for this purpose. These omissions can be quite serious, particularly in the case of developing countries where adequate records are not maintained. Moreover, in the absence of records, most individuals and households are not able to provide correct information of their consumption and investment values. (c) In some cases, relevant information may not be available to the authorities because the households and business units required to provide the information may have reasons to hide the information. In still other cases, they may not have the exact information. 4. The national income estimates do not cover illegal activities even though they may be adding to national product. They include smuggling, inland trade activities, production and income generation concealed from the authorities for avoiding tax obligations and prosecution etc. 5. Several economic activities only add to the disutility of the members of society and entail use of resources (resource cost) which could be used for more productive purposes. But an increase in such activities is taken to add to national income rather than reduce it. For example, let us take the case of a worker who has shifted his residence to a greater distance from his work place. Therefore, compared with the earlier situation, he has to commute a longer distance to his work and has to spend additional time, effort and money for doing so. Though, in reality, both the individual worker and the country are losers on account of the shifting of residence of this worker, national income estimates record the additional resource cost as an addition to national income. 6. Similarly, economic activities of the country may add to the output of goods and services (like drugs) which adversely affect the health and productivity of their users. But national income estimates do not take this fact into account. As long as a good or service has a market value, its production is added to the national income estimates.

Dept. of MBA, PESIT

2012-2013

11

Term Paper on Methods of Measuring the National Income

7. National income estimates include profit of the corporate sector. However, the profit of a business does not reflect the productive contribution of the entrepreneurship. Instead, it varies in relation to several factors like the overall expected or prevailing rate of profit in the economy. This rate itself tends to vary from economy to economy, region-to-region, industry to industry and with the passage of time. In this context, mention may also be made of the fact that a large number of public sector undertakings are not run with the motive of earning a profit, while during a period of deficient demand, even private enterprises often fail to earn a profit. As a result, national income estimates can vary simply because of shifts in rate of profit without any, corresponding change in real output.

Dept. of MBA, PESIT

2012-2013

12

Term Paper on Methods of Measuring the National Income

CONCLUSION
National income analysis provides us a complete knowledge about the trends in national income which is essential in economic planning. The statistics help in removing the inequalities in income distribution. The national income plays a major role in: Measures inflationary or deflationary pressure Estimates the contribution of various sectors Assesses the distribution of national income in an economy Shapes the budgetary policy of the government Assists in the planning of an economy

Dept. of MBA, PESIT

2012-2013

13

Term Paper on Methods of Measuring the National Income

BIBLIOGRAPHY
www.google.com www.wikipedia.org www.yourarticlelibrary.com www.leadthecompetition.in www.guesspapers.net

Dept. of MBA, PESIT

2012-2013

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