ESTIMATION OF NATIONAL INCOME

There are three methods to estimate national income:

i) Product method/ value added method/ output method

ii) Income method
iii) Expenditure method/ Total outlay method

Estimation of national income by product method

There are four steps involved in estimation of national income by product method.

Step I.

Identification and classification of production unit

The entire production units in an economy are generally classified into three sectors.

1. Primary sector-it consists of those production units which produce commodity by

exploiting natural resources such as agriculture, forestry, fishing, mining, etc.

2. Secondary sector- this sector transform one type of commodity into another type such
as manufacturing clothes from cotton.

3. Tertiary sector- this sector provides various types of services such as transport,
communication, banking, insurance, etc.

Step II.

Estimation of net value added by each enterprise:

I. Value of gross output by each enterprise is made by multiplying its product by market
prices.
II. Gross value added by the enterprises is calculated by deducting the value of
intermediate consumption so as to avoid double counting.
III. Net value added at market price by each enterprise is estimated by deducting the value
of depreciation from the gross value.
IV. From the net value added at market price deduct Net Indirect Tax (NIT) so as to arrive at
value added at factor cost.
Step III.

Net value added at factor cost / NDPFC= Value of gross output - Intermediate consumption-
Depreciation - Net indirect tax.

Step IV.

Estimation of Net Factor Income from Abroad (NFIFA)

The final step is to estimate NFIFA. National income is obtained by adding NFIFA to the NDP FC.

Therefore,

NNPFC/ National Income= Net value added at factor cost of primary sector + secondary sector
+ tertiary sector+ NFIFA.

OR

NNPFC = NDPFC +NFIFA

Precautions in Estimation of National Income by Product Method

I. Value of goods produced for self consumption such as food grains produced by a farmer
for the consumption of his family should be included.

II. Services of house wife such as cooking meals, cleaning, washing, looking after children,
etc are excluded because such services are out of love and affection. It is non- economic
activity.
III. Own account production of fixed assets such as residential building by the household
and factory building by producers should be included. Imputed rent should be included
while calculating national income.

IV. National income measures the value of only currently produced goods and services
Transfer payments are not included.
Measurement of NY/NNPFC by Income Method

National income under income method is calculated by adding up all the income generated
while producing the national product. This method involves the following steps:

Step I.

The first step identifies producer enterprises which employs factor services (land, labor, capital,
entrepreneur). These enterprises are classified into:

1. Agriculture
2. Mining
3. Forestry
4. Manufacturing
5. Electricity
6. Trade
7. Transport and communication
8. …..Banking and insurance
9. Government and for personal services.

Step II.

The factor incomes are grouped under different categories

 Land
 capital
 Labor
 Enterprise/organization

Factor payments by the enterprise are rent, wages, interest, profits. Accordingly factor incomes
are classified into:

A) Compensation of employees/ labor income

B) Operating surplus
C) Mixed income
Step III.

In the third stage the domestic factor income is estimated by adding all the factor incomes.

NDPFC = A+B+C or,

NDPFC=COE +OS+ MI
Step IV:

In the last stage, net factor income from abroad (NFIFA) is added to arrive at National Income.

NNPFC/NY= COE + OS + MI + NFIFA

Precautions in estimation of national income or NNPFC by Income method

While estimating national income by income method, we should include the following two
items;

1) Value of production for self consumption such as agricultural product used by the
farmers.
2) Imputed rent of the owner occupied houses.

While estimating national income, we should exclude the following;

1) All the transfer incomes such as pensions, scholarships, donation, charity etc.,
2) Illegal incomes like income from smuggling, drug-dealer, and gambler etc., because
these incomes are illegal and are unaccountable.
3) Money received from the sale of second hand goods because they are not part of
current years’ output.
4) Private transfer payment such as pocket money given by the parents to their children.
5) A windfall gain such as income from lottery as they do not contribute to current flows of
goods and services.
6) Profit before tax is included, so corporate tax should not be included separately.
EXPENDITURE / TOTAL OUTLAY METHOD

Expenditure method measures national income by estimating expenditure on final products.

STEP I

All the economic units which incur expenditure on final goods and services are divided into four
groups:

1) Households
2) Business sector
3) Government sector
4) Rest of the world

STEP II

Expenditure on final goods and services mainly consists of the following;

A) Consumption expenditure
B) Investment expenditure
C) Government expenditure
D) Net exports

A) Consumption expenditure comprises of the following;

i) Expenditure on single use goods such as food

ii) Expenditure on durable use goods like car
iii) Expenditure on services like education, health etc.,
Therefore,
i + ii + iii = Gross Domestic Consumption Expenditure

B) Investment expenditure consists of the following;

i) Expenditure on business fixed assets like building, plants etc.,

ii) Inventory investments includes unsold goods in warehouses, showrooms etc.,
iii) Expenditure on residential investment such as purchase of new houses.
Therefore,
i + ii + iii = Gross Domestic Investment

C) Government expenditure consists of expenses on administration, defense, law and

order, social services etc.,
 D) Estimation of net export
The difference between the value of goods and services exported to other countries and
imported from other countries is called net export.

STEP III

In the third stage we find out final expenditure by adding

A + B + C + D = NDPFC
NDPFC = consumption expenditure + investment expenditure + government expenditure + net
export

STEP IV

In the final step NFIFA and NIT are estimated and added to NDPFC

Therefore, NNPFC = NDPFC + NFIFA

OR

NY = C + In + G + (X-M) – NIT + NFIFA.

Where;

C = Consumption expenditure

In = Investment expenditure

G = Government expenditure

(X-M) = Net export

NIT = Net Indirect Tax

NFIFA = Net Factor Income from Abroad

NY = National Income
Precaution of expenditure method;
i) Many final products are not purchased from the market but produced and
consumed such as farmer consuming food grains and owner occupied houses
are to be included in the estimation of national income.
ii) Expenditure on intermediate products is excluded in order to avoid double
counting.
iii) All the expenditure on second hand purchases must be excluded because it
only reflects the transfer in the ownership and nothing new is being
produced.
iv) Government expenditure on transfer payments is excluded because it is
unilateral transactions (receiver does not contribute to its current output).

Difficulties in measurement of national income

1) Conceptual difficulties

i) Inclusion of services in national income is one of the problems. There is

difference in opinion as to whether to include or not. Some economists believe
that services should be excluded, while the other says it should be included.

ii) Identifying intermediate goods is another problem because same goods are
treated differently; it is difficult to draw a clear cut distinction between
intermediate goods and final goods. For example, Flour used by a bakery is
intermediate good, while same flour used by household is a final good.

iii) Services of housewives and similar services are services for which payment is
not made in money form. Therefore, they are not included in national income.
However similar services performed by hired workers are included.

iv) Incomes of the foreign firms should be included in national income or not. One
view point is that the income which the foreign firms retain in the country should
be included in the national income and the income which is remitted to abroad
should not be included.
 v) Estimation of depreciation is also a difficult task. Depreciation of a piece of
capital can be estimated at its original cost (historic cost) or at its replacement
cost.

PRACTICAL DIFFICULTIES

1) Lack of occupational specialization- In developing countries like India and Bhutan

occupational classifications of producers into distinct groups is almost impossible,
particularly in agricultural sector. A substantial proportion of working population
undertakes more than one activity during a year. In such case, it is very difficult to assign
any particular occupation to him and allocate his income. For example; during off season
a farmer can work as a part time rickshaw puller.

2) Non-monetized sector- a very large part of production does not come to the market for
sale. It is partly kept back by producers for their personal consumption and is partly
exchanged for other goods. Such goods and services which do not enter the market
need to be included in national income. Therefore, absence of data about such goods
and services makes the imputation all the more difficult (it is based guess work).

3) Inadequate information- a very large part of production activity in the developing

countries is unorganized consisting of small farmers, small shop keepers and small
artisans. Most of these small producers do not keep account of their production and
income. Under these circumstances, the estimates of output and income are simply
guess work.

4) Unreported illegal income- sometimes people distort facts and provide false
information about their income to evade income tax and wealth tax. These leads to
generation of black money, which is unaccountable.

5) Non-availability of reliable data- a large number of enumerators entrusted with the

task of collecting data at the village level are untrained in collection of data. Moreover,
data in respect of consumption, savings and investment expenditures are incomplete,
inadequate and not reliable.

Notes compiled and prepared by Radhika Rai Kuendrup Higher Secondary School, Gelephu.