Three approaches of Measurement of National Income and Its Measurement Difficulties

Three approaches to measurement of National Income

In an economy, the total product, total income, and total expenditure are always identical with each other. So, the national income can be viewed in terms of triple identity between output, income, and expenditure i.e.

National product = National Income = National Expenditure.

Hence, there are three types of a measurement system for national income. They are (i) Product method, (ii) Income method and (iii) Expenditure method.

1. Product Method

This approach is also called output method or inventory method as it measures income from the output side. In this approach, we add up the specific value of the flows of output arising from each sector of the economy. As per this method, the economy is divided into different industrial sectors to show the contribution made by each sector to GDP. Then, the national income is calculated by adding the value of final goods from all the sectors that have taken place during a year. Final goods are those goods which are directly consumed and not used in further production process.
In order to avoid the problem of double counting, there are two methods for calculating national income viz; final product method and value-added method. 

i. Final product Method
In this method in estimating GDP, the only final value of goods and services are computed ignoring all intermediate transaction, Intermediate goods are those which are further processed to produce final goods. In this approach, national income is calculated by finding the market value of all final goods and services produced within the country during the time period of one year.

Thus, GDP = market value of all final goods and services produced within the country.

ii. Value added method
This is also the another method of avoiding double counting in calculating national income in which the country’s income is measured by adding the differences between the values of inputs and output at each stage of production. As per this method, income is the sum of value added by different producing units of a country in their production process.

Hence, Value added = Value of output – Cost of production

For the purpose of estimating value added, the following steps are generally applied:

1. Identifying the production units and classifying them under different industrial activities.
2. Estimating net value added by each production unit in an industrial sector.
3. Adding up the total value added of each final product to calculate GDP.

This method is considered very useful as it helps to get some very important information about the contribution made by each of the different production sectors of the economy to the value of GDP. It also gives us an idea about the current structure of national income and changes in the structure over the period of time.

2. Income Method

The income method of calculating national income is also called the factor income method or factor share method. This method measures national income from distribution side i.e. the national income is measured after it has been distributed and appears as income earned by individuals in the country. To estimate the national income by this approach, the total sum of the factor payments received during a given period is estimated. The factors of production are classified as land, labor, capital and organization. Accordingly, the national income is calculated as the sum of various factor payments like rent, wages, interest and profits plus depreciation.

Thus, National income = Rent + Wages + Interest + Profits + Depreciation

This method of estimating national income is of great advantage as it shows the distribution of national income among different income groups such as landlords, capitalists, workers, etc. It is therefore called national income by distributive shares.

3. Expenditure Method

The expenditure method is also known as the final product method, which measures the national income at the final expenditure stage. In other words, it measures national income as the aggregate of all final expenditure on Gross Domestic Product in an economy within a year. Hence, expenditure method measured the disposal of GDP.

This method calculates national income by adding up all the expenditures made on goods and services during a year. Income can be spent either on consumer goods or investment goods. Hence, the national income is calculated by adding consumption expenditure and investment expenditure made by individuals as well as government during a period of one year. National income is calculated by adding:

i. Personal consumption expenditure(C): It is the household sector’s purchases of currently produced goods and services. Consumption can be broken down into consumer goods (automobiles, televisions) , non-durable goods (foods, beverages) and consumer goods (medical services, haircuts).

ii. Gross domestic investment (I): It consists of expenditure of private business on replacement, renewals and new investment.

iii. Government expenditure (G): It refers to the government purchases of goods and services. Government transfer payments to individuals and government interest payments are examples of government expenditure.

iv. Net export(X): Net export equal total exports minus imports. It represents the contribution of foreign sector in the national economy.
Hence, GDP = C + I + G + X

Measurement Difficulties of National Income

There are various theoretical as well as practical difficulties in calculating the national income. A clear understanding of such problems can reduce the problems in the counting of national income. The measurement difficulties of national income are discussed below:

i. Problem of double counting
Double counting refers to the calculation of the value commodity in national income more than one times which overestimate the value of national income. Sometimes, the same goods can be counted as intermediate goods and final goods. This causes the double counting of same product.

ii. Calculation of Depreciation
The depreciation deducted from Gross National Product gives Net National Product which is the net income of country. But, it is difficult to estimate the accurate depreciated value as it differs from product to product.

iii. Change in value of money
National income is measure in monetary terms and value of money does not remain stable. It, therefore, cannot give a correct account of national income.

iv. Illegal income
Income earned through illegal means like gambling, prostitution, black marketing, drug dealing etc. are not included in national income, which underestimates the value of national income.

v. Non- availability of reliable data
National income calculation required reliable and accurate statistical data. The available data are inadequate and unreliable which creates in calculating an accurate value of national income.

vi. Choice of method
The difficulty in choosing the right method for calculating national income sometimes create a problem in finding the accurate estimate of national income.

vii. Non-market activities
National income is the market value of all goods and services. But there are many activities like services of housewife and labors that do not appear in the market which underestimate national income.

viii. Existence of non-monetized sectors
All the agricultural production does not reach the market. Some portion of the production is consumed within the house which is not included in national income.

ix. Illiteracy and ignorance
The majority of small producers in the underdeveloped countries are illiterate and ignorant. They cannot keep the account of their production. So they cannot give information about the value of their output.

x. Lack of occupational specialization
Occupationally specialized people in underdeveloped country are very less. Because of insecurity of one occupation a people engages in various occupational activities. It causes difficulty in collecting information about their income from each sector.

xi. International transactions
National income determination in an economy having international economic relation would create a number of problems which may have difficulty in calculating the part of income earned by foreign sector.

References

Dwivedi, D. N. (2010). Macroeconomics theory and policy. New Delhi: Tata McGraw-Hill Education.

Kharel, K. R., Ghimire, Y., Bhattarai, D., Jnawali, S., & Paudel, K. (2010). Business Economics. Kathmandu: Sukunda Pustak Bhawan.