Measurement of National Income – 2. Income Method

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Measurement of National Income - 2. Income Method
The income method measures national income from the side of factor income. This method is also known as the factor payment method. According to this method, the incomes received by all the residents of a country for their productive services during a year are added up to obtain national income. Thus, the income method consists of income earned by all factors of production in the form of wages and salaries, interest, rent, and profit. All these incomes earned by individuals and households are summed up to calculate NDP at FC. When factor income earned from abroad is added to NDP at FC then we get NNP at FC.
This method measures NDP at FC from the distribution side. NDP can be computed by summing up the incomes received by factors of production. NNP at FC is the sum of the payment made to or income received (i.e., wages, rent, interest, and profit) by the factor of production plus net factor income from abroad. The remaining two items of payments- indirect business taxes fewer subsidies and depreciation are categorized as non-income (expense) items, which are summed up to get gross income at market price.

The important elements or components in the calculation of national income by income method are as follows:

1. Wages and salaries: Wages and salaries earned by labor and employees are included in the national income. It includes all forms of remuneration for work. Thus, it includes not only wages and salaries but also bonuses, commissions, payments in kind, incentive payments, employer’s contribution to social security tips and fringe benefits, etc. The total sum of income earned by labor and employees is also called compensation of employees which is the sum of wages and salaries and the employer’s contribution to the social security or provident funds, etc.
Compensation of employees = Wages, and salaries + Employers’ contribution to social security + Bonus + Money value of other facilities
2. Rent: Rent received from land, buildings, factories, etc. included in national income. Income earned by persons for the use of their real property such as a house, store, or farm is rent. This component also includes the estimated rental value of owner-occupied dwellings and royalties received by persons from patents, copyrights, and rights to natural resources.
3. Interest: Interests received from the capital are included in the national income. Interest is expressed in net rather than gross terms. It represents the business sector’s total interest payments to other sectors minus their total interest payments to the business sectors. All other types of interest payments between individuals, between businesses, and between government and individuals are considered unproductive and hence are omitted from the calculation of GDP.
4. Profits: Profits that include dividends, profit tax, and undistributed profits are included in the national income. Profit consists of corporate profits before payments of corporate income taxes or disbursement of dividends to stockholders. Profits of unincorporated businesses (i.e., partnership arid proprietorship businesses) are not counted here because they were already included as part of wages.
Profit = Undistributed profit + Dividend + Corporate income tax
5. Net indirect taxes: Net indirect tax is equal to indirect taxes with fewer subsidies. This indirect tax consists primarily of sales or value-added tax (VAT), excise, and real property taxes incurred by businesses. It is considered a business expense — the same as wages and other costs. Though the final burden of such taxes is borne by the final consumer in the form of higher prices, it is included in GDP. This is because the indirect taxes cause the expenditure side of GDP to be greater than the income side. On the other hand, subsidies cause the expenditure side to be lower than the income side. Therefore, indirect taxes are deducted and subsidies are added to get GDP at factor cost.
Net indirect taxes = Indirect taxes — Subsidies
6. Net factor income from Abroad: The net factor income from abroad is income included in the national income. Net factor income from abroad is equal to income received by citizens of a country from abroad less income paid to foreigners. It is added to the GDP to get GNP.
7. Depreciation: The depreciation amount is deducted from gross income to get net income i.e., net national product (NNP). Depreciation is the wear and tear of fixed assets and machinery. It is also known as the capital consumption allowance.
8. Mixed-income and income from self-employment: Income earned by self-employed persons and profit of the small business or sole proprietorship or household industries is included in national income. The profit or income earned from sole proprietorship or partnership is called mixed-income or proprietors of income.

The method of calculating NI by income method is as follows:

NDP at FC (NDPfc) = Wages and salaries + Rent + Profit + Interest + Income from self employment + Mixed income or proprietor’s income

NDP at FC (NNPfc) = NDP at FC + Net factor income from abroad

NI = NNP at FC

Alternative method,

GDP at MP (GDPmp) = Compensation of employees + Rent + Profit + Interest + from self employrnent + Mixed income or Proprietor’s income + Deprection + 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) = NNP at MP – Net indirect taxes

NI = NNP at FC

This method requires careful specification of what is to be included under the heading of income. In general, we may include only these particular income flows that originate with the production of goods and services. The following incomes are not considered as income and hence excluded from NI:

1. Amount received from the sale of used goods or second-hand goods such as buildings, automobiles, or any other goods produced in an earlier time period because what they receive in payment is not “income” in the sense of something generated in the course of producing the output of the current period.
2. Amount received from the sale of stocks or bonds.

3. Amount received from the government in the form of transfer payment because recipients provide no goods or services in exchange.

4. Income received by people from other individuals for which no productive service is provided.

This approach is not possible to use in developing countries like Nepal because of the statistical measurement problems. For instance, incomes earned by a factor of production are not readily available in Nepal. Moreover, this is not in practice yet. Therefore, Nepal is unable to apply this approach to measuring NI.

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