Macroeconomics

Measurement
Part 2: Measurement of National
Income
Measurement
 Production of goods and services gives rise to income;
income gives rise to demand for goods and services;
demand gives rise to expenditure; and expenditure gives
rise to further production. There is circular flow of
production, income and expenditure.
 Based on flow, there are three methods:
 Product Method,
 Income Method and
 Expenditure Method
PRODUCT METHOD
 It measures national income at the phase of production in
circular flow.
 It measure from the output of the economy.
 In this method, economy is divided into three sectors:
 Primary Sector: agriculture, forestry, fishing, mining, etc.
 Secondary Sector: manufacturing, construction, electricity, gas,
water supply. etc.
 Tertiary or Service Sector: banking, transport, insurance,
communication, trade and commerce, etc.

 There is more possibility of double counting which leads to

overestimation of NI so to avoid the problem of double
counting, following two methods are used: (a) Final Product
Method and (b) Value Added Method
(a) 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. Intermediate
goods are avoided.
 GDP at MP = Market value of all final goods and service 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

 GNP at MP = GDP at MP + Net factor income from aboard (NFIA)

 NNP at MP = GNP at MP – Depreciation
 NNP at FC = NNP – Net Indirect taxes
 NI = NNP at FC
(b) Value Added Method
 The value added or created at different stages of production is
counted for estimating national income.
 Vale 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.
Cost of
Stage of Value of Output Intermediate Gross Value
Producer Production (Rs.) Goods (Rs.) Added (Rs.)
Farmer Wheat 100 - 100
Miller Flour 150 100 50
Baker Bread 250 150 100
  Total 500 250 250
 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 = NDP at FC + NFIA
 NI = NNP at FC
(b) Value Added Method

Alternative Method:
GDP at MP = Net value added + Depreciation + Net indirect taxes
GNP at MP = GDP at MP + NFIA

NNP at MP = GNP at MP – Depreciation

NNP at FC = GNP at MP – Net indirect taxes

NI = NNP at FC
INCOME METHOD
 It measures national income from the side of factor income. It consists of income
earned by all factors of production in the form of wages and salaries, interest, rent
and profit.
 NDP at FC = Wages and salaries + Rent + Profit + Interest + Income from self
employment + Mixed income or proprietor’s income
 NNP at FC = NDP at FC + NFIA

 NI = NNP at FC

Alternative Method:
 GDP at MP = Compensation of employees + Rent + Profit + Interest + Income
from self employment + Mixed income or Proprietor’s income + Depreciation +
Net indirect taxes
 GNP at MP = GDP at MP + NFIA

 NNP at MP = GNP at MP – Depreciation

 NNP at FC = NNP at MP – Net indirect taxes

 NI = NNP at FC
Items in Income Method
 National income is the sum of five components: (1) compensation of
employees, (2) proprietors’ income, (3) corporate profits, (4) rental income of
persons, and (5) net interest
 Compensation of employees: Sum of (a) wages and salaries paid to
employees, (b) employers’ contributions to social security and employee
benefit plans, © the monetary value of fringe benefits, tips, and paid
vacations
 Proprietors’ Income: All forms of income earned by self-employed individuals
and the owners of unincorporated businesses, including unincorporated
farmers.
 Corporate Profits: Profits include profits of large corporations, and also the
income of small businesses and farm (proprietor’s income excluded). It
include all the income earned by the stockholders of corporations in the form
of dividends or undistributed profits or retained earnings. It also include
corporate profit taxes.
Items in Income Method
 Rental Income (of Persons): It is the income received by individuals for the
use of their non-monetary assets (land, houses, offices). It also include
estimated rent value of owner-occupied dwellings and royalties received by
persons from patents, copyrights and rights to natural resources.
 Net Interest: It is the interest income received by households and
government minus the interest they paid out. It represents the business
sector’s total interest payments to other sectors minus their total interest
payments to the business sectors.
 Income earned from/by the rest of the world (NFIA): Here (a) subtracting
from national income the income earned from the rest of the world (this is
income that a citizen of the country living abroad earned by producing and
selling goods) and (b) adding to national income the income earned by the
rest of the world (this is income that non-citizens earned by producing and
selling goods in the country)
Items in Income Method
 Indirect Business Taxes: Indirect business taxes are made up mainly
of excise taxes, sales taxes, and property taxes. Indirect tax is paid
directly by businesses to the government and is regarded as a
business expense – the same as wages and other costs. The burden
of payment is shifted from firms to buyers. Those taxes are part of the
income generated in producing GDP. Here while calculating GDP at
MP the indirect business taxes should be added and government
subsidies should be subtracted.
 Capital Consumption Allowance/ Depreciation: It is the charge or cost
of replacement on capital goods for their natural wear, obsolescence,
or accidental destruction. To reveal correctly the total income for the
economy, depreciation charge must be made against the economy’s
private and public stock of capital (public capital includes government
building, port facilities, public highways and so on)
Items in Income Method
 Statistical Discrepancy: Unreported data or errors in data collection
is termed as statistical discrepancy. It reflects errors and omissions
made in collecting data on income or spending.
Tables for Income Method

Items Amount
Compensation of employees -
Proprietors' income -
Rental income of persons -
Corporate profits -
Net interest -
Taxes on production and imports -
Business current transfer payments -
Current surplus of government enterprises -
National Income -
Statistical discrepancy (+) -
Net National Product (NNP) -
Consumption of fixed capital (+) -
Gross National Product (GNP) -
Factor income received from the rest of the world (-) -
Payments of factor income to the rest of the world (+) -
Gross Domestic Product (GDP) -
Assignment

 Review the Article given in the following link:

http://republica.nagariknetwork.com/news/42019/

 Why aren’t stock purchases and sales

counted in GDP?
 Study Exhibit 4 & 6; GDP: Proceed with
Caution