A. Define national income and explain the three methods used for its calculations. J.M.
Keynes, a famous economist defined national income as follows, "National Income is
the monetary value of all goods and services produced in a country during a year."
When calculating the national income the all productive activities, which contribute to the provision of goods and services, are included. Hence, the reason national income is referred to as national product. National income (product) in most instances is measured using the “gross” or “net”. Gross National Product (GNP) refers to the sum of the values of all finished goods and services produced inclusive of investments of residents both locally and abroad. Whereas, the net national product take into consideration the consumption of fixed capital during the process of production and make allowances for depreciation. Continuous increase in production can be considered as an index of progress that an economy has achieved. This increase in production will also show an increase in consumption. This give rise to the concept that income = expenditure = output. To explain this concept further the circular flow of income would be applied.
INCOME (wages, rent, interests, profits) FACTORS OF PRODUCTION
OUTPUT (goods and services) CONSUMER EXPENDITURES
In the diagram above, we see the two main sectors of the economy; the household and the firm. The households are the consumers while the firms are the producers. The households own the factors of production namely, land, labour, capital and enterprise at the same time the firms use the factor services from the households to produce goods and services. In return for factor services the firms pays the households an income, which
would be spent on commodities and services, produced by the firms. The volume of these payments would give us the total income from producing and subsequently we would get the value of the national product. With the aid of the diagram given above, we can see the mutual relationship of production, income and expenditure. Economic activity is directly related to these three stages. Based on this, it is evident that there are three methods are used for calculating national income. They are: − The Income approach is the total amount of money earned by factors of production during the process of producing the goods and services. − Production (output) approach is the total value of all final goods and services produced by the firm. − Expenditure approach is the total monetary value spent on final goods and services. The Income Approach Factors of production owned by the households and firms together produce output and income. The income received by the factors of production during a year can be obtained by adding rent of land, wages and salaries of labour, interest on capital and profit from organisations and the sum of these will give the Gross National Product. However, during the production of the GNP, capitals are being used and an allowance for this consumption is called depreciation. Once depreciation is deducted from the gross national production, we would derive at the Net National Product (NNP). In other words, Net National Product = Gross National Product - Depreciation NNP can be assessed at market prices where duties are included in the NNP or at factor cost where indirect taxes and subsidies are deducted from the NNP. Therefore, NNP at market prices = Gross National Product +Duties – Depreciation NNP at factor cost = NNP at market prices – (indirect taxes + subsidies) The Production (output) Approach 2
The sum of the values of all final goods and services produced in each sector and net foreign factor income earned. This method helps us to find out contributions of various sectors to national income. Some of the sectors that contribute to the Gross Domestic Product are agriculture, mining, manufacturing, public utilities (electricity, water and gas), construction, financial services, education, health and other services. These sectors can be further classified into production units called primary, secondary and tertiary. The table below illustrates the sectors in their respective units. Production Units Secondary Public utilities Manufacturing Trade
Primary Agriculture Forestry Fishing Mining
Tertiary Communications Banking/Insurance Public Administration Health Education Other services
The Expenditure Approach The total of all expenditures incurred on final goods and services. Government as well as private individuals spend money for consumption and production purposes, these can be classed as consumption goods and services (consumption expenditure), investment goods (investment expenditure), public goods and services (government expenditure) and net exports which comprise of exports less imports. Consumption expenditure is the aggregate expenditure on goods and services, while investment expenditure is the flow of expenditure on new fixed capital or for additional stocks. Government expenditure comprises of the expenses of the government for departmental goods and services, payment of welfare and social security benefits and on capital expenditure. Finally, there are the net exports, this occurs when money is spent on importation of goods and services which in turn leads to a reduction in the purchasing power from a country. The expenditure approach would be listed as follows.
Investment Government expenditure Total final expenditure Less: imports Expenditure on GDP Net Income from abroad GNP at factor cost
xxxx xxxx xxxx xxxx xxxx xxxx xxxx
B. Identify and explain the difficulties experienced in the calculation of National Income. In most countries, the National Income or Gross National Product (GNP) acts as a guide to the economic status of the country. However, there are difficulties in calculation especially in lesser-developed countries. Within lesser-developed countries, proper record keeping of economic activity may not exist at all because of extensive bartering. In addition, the figures for the National Income can be undervalued because of non-market and illegal goods distort the amounts and the arbitrary exclusion of certain items plus omission of paid services for housekeeping and payments-in-kind. Also, within poorer countries live on the primary units such as agriculture, farming and fishing. Even if the calculations of the figures are accurate, this may not reflect the standard of living, which is not accounted for in estimates per capita income. The standard of living refers to the level of well-being but also encompasses other levels of health care, amount of leisure time, quality of the environment, degree of social cohesion and political stability. For example, Taiwan is a vastly developed industrial nation but suffers from pollution and congestion, while in Saudi Arabia wealth is concentrated amongst the rich oil-sheiks while the rest of the country does not enjoy the same standard of living. A country’s national income figures may be very high, but the hours of work may be very long and they are entitled to few holidays.
Another serious problem in the calculation of the national income is double counting. Activities that are related to the final consumption are included in the calculations but within the private sector, all purchase outside the firm are excluded in the totalling of the national income. While national income statistics are efficient and convenient means for evaluating a country’s economy, it can be misleading, as it does not produce a fully accurate picture of the country’s economy as a whole. C. Identify and explain the practical uses of National Income statistics. National Income figures are mainly used to measure the economic well being of a country, over a space and time. National Income figures help the government in their economic planning, taxation and trade policies inclusive of direct controls. The figures indicate the sectors where the economy is doing well and where it is not and subsequently resources will be diverted to the needed areas. In addition, taxes could be raised from companies and individuals who are doing well and subsidies and tax concessions would be offered to assist productive sectors and individuals who are in financial difficulty. Figures from the national income statement provide a detailed account of the country’s balance of payment. By studying the causes for deficit or surplus, the government can take steps to achieve long-term equilibrium. Finally, the national income statistics would be useful in reporting on the investment potential of the country as would be determined by the Gross Domestic fixed Capital formation. A high level of investment would prove attractive to foreign investors, although this would have to be supplemented by other factors such as political stability and labour conditions.