Measurement of National Income – 1. Product Method
MEASUREMENT OF NATIONAL INCOME
Production of goods and services gives rise to income; income gives rise to the demand for goods and services; demand gives rise to expenditure, and expenditure gives rise to further production. Thus, there is a circular flow of production, income, and expenditure. Based on these three related flows, national income can be measured by using three methods: product method, income method, and expenditure method, which are explained below:
The product method measures national income at the phase of production in a circular flow. In this method, the national income is measured from the output of the economy in a given period. All the goods and services produced during a year in the economy are measured at the market price.
In this method, the economy is divided into three sectors: primary sector (agriculture, forestry, fishing, mining, etc.), secondary sector (manufacturing, construction, electricity, gas, water supply, etc.), and tertiary or service sector (banking, transport, insurance, communication, trade, and commerce, etc.). The money value of the total production of every sector is calculated and summed up to find out GDP at MP. The GDP at MP so derived can be changed into GNP at MP by adding net factor income from abroad.
This method is common in many countries but there is more possibility of double counting. Double counting means certain items are counted more than once while calculating national income. It leads to an overestimation of NI. To avoid the problem of double counting, the following two methods are used:
1. Final Product Method
In the final product method, national income is estimated by finding the market value of all final goods and services _produced in an economy in a year. The various steps to the estimation or calculation of national income according to this method are as follows:
• The market value of all final goods and services produced within the country in a year is calculated which is known as GDP at MP.
GDP at MP = Market value of all final goods services produced in the country
= Money value all final goods and services produced in all economic sectors (agriculture, industry, trade, and service) within a country in a year
= P1Q1 + P2Q2 + P3Q3 +……….+PnQn
= n summation i=1*PiQi
P =Price of the respective goods and services
Q =Quantity of goods and services
i =Final product from 1 to n.
• By adding the net factor income from abroad to GDP at MP, we get GNP at
GNP at MP = GDP at MP + Net factor income from aboard
• In order to get NNP at MP, depreciation is deducted from GNP at MP
NNP at MP = GNP at MP – Depreciation
• Further deducting net indirect taxes from NNP at M.P., we obtain NNP at factor cost which is national income.
NNP at FC = NNP – Net Indirect taxes
NI = NNP at FC
While calculating NI through the final product method, the problem of double counting occurs. In order to avoid double-counting, only final products should be included and the value of intermediate products should be excluded. But it is very difficult to avoid double-counting because the same product is used as the intermediate good by firms and the final good by households. For example, flour is used as the intermediate good by biscuit industries whereas it is used as a final product by households for making bread. Another way to avoid the problem of double counting is a value-added method which is explained below.
2. Value Added Method
In the value-added method, the value-added or created at different stages of production is counted for estimating national income. Thus, according to this method, national income is the sum of total value added by different producing units of a country in their production process. Value-added means the addition to the value of raw materials and other inputs during the process of production. Value-added, in fact, refers to the productive contribution of an enterprise. In order to calculate the value-added at a particular stage of production, the cost of an intermediate product is deducted from the total value of output. Thus,
Gross value added = Value of output Cost of intermediate goods
Value added is the difference between the value of goods as they leave a stage of production and the cost of the goods as they entered that stage. In calculating GDP, we sum up the value-added at each stage of production.
This method is used to avoid the problem of double counting. The sum of net value added in all sectors of an economy gives NDP at factor cost. NDP at factor cost plus net indirect tax and depreciation gives GDP at market price. The various steps in the calculation of NI by a value-added method is given below:
Net Value Added = Gross value added — Depreciation
NDP at FC (NDPfc) = Sum of net value added in all sectors of an economy i.e., primary sector, secondary sector, and tertiary sector or service sector
NNP at FC (NNPfc) = NDP at FC + Net factor income from abroad
NI = NNP at FC
GDP at MP (GDPmp) = Netvalue added+Depreciation+Net indirect taxes
GNP at MP (GNPmp) = GDP at MP+Net factor income from abroad
NNP at MP(NNPmp)= GNP at MP – Depreciation
NNP at FC (NNPfc) = GNP at MP – Net indirect taxes
NI = NNP at FC