National Income Concept and Measurement

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Circular Flow of Income and Expenditure
The circular flow of income or circular flow is a model of the economy in
which the major exchanges are represented as flows of money, goods and
services, etc. between economic agents. The flows of money and goods
exchanged in a closed circuit correspond in value, but run in the opposite
direction. The circular flow analysis is the basis of national accounts and hence of
macroeconomics.
Major sectors and actors in the macroeconomic circular flow

 Household Sector
 Business Sector
 Government
 Foreign Sector
# Physical Flow
# Monetary Flow

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Circular Flow of Income and Expenditure -Two Sector
Economy
The circular flow model in the two-sector economy is a hypothetical concept which
states that there are only two sectors in the economy, household sector and business sector
(business firms).
The household sector is the source of factors of production who earn by providing factor
services to the business sector. The business sector refers to the firms that produce goods and
services, and receive income by supplying the produced goods to the household sector.
The state of equilibrium in the two-sector economy is defined as a situation in which no
change occurs in the levels of income (Y), expenditure (E), and output (O).
I.e. Y=E=O

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Assumptions
 There are only two sectors in the economy; household sector and business
sector.
 No government interventions over the economic activities.
 Business sectors do not carry out any import or export activities, creating a
closed economy.
 Business sector produces goods and services and sells them to the business
sector.
 Household sector is the owner of factors of production and sells them to
the business sector.
 All income is spent on consumption .There is no saving.

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Circular Flow of Income and Expenditure in the
Two Sector Economy

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Explanation of Circular Flow of Income and Expenditure

The outer circle represents real flow and the inner circle represents the monetary flow.
Real flow indicates the factor services flow from household sector to the business sector, and
goods and services flow from business sector to the household.
Monetary flow illustrates that, in terms of money, factor rent, wage, interest and profit
flows from the business sector to household sector. On the other hand, the consumption
expenditure made by households flow to the business sector as revenue for the firms.
This means that the expenses made by the households become the source of income
for the business sector or the firms and vice versa. The firms provide payment to the factory
owners for procuring factors of production. Further, the factor owners spend this i ncome on
goods and services produced by the business sector, which becomes revenue for the business
sector.
Since the households spend their income, the total monetary receipts of business sector
will be equal to the income and consumption expenditure of the household sector. This means,
monetary receipts of the producers = income of the households = consumption expenditure of
the households. In this way, an equilibrium state exists in the economy where total demand
equals total supply.
Thus the circular movement of income and expenditure in the economy continues,
leading to equalization in the gross national product and gross national income.
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Circular Flow of Income and Expenditure-Three Sector
Economy
In the circular flow model three sector economy, government intervention has also
been accounted for, although it is still assumed to be a closed economy where the income flow
is not influenced by any foreign sector. Besides the income and expenditure of the households
and business firms, government purchases or expenditures and taxation also come into play.
Here, government purchases are injections into the circular flow, while, taxation is a leakage.
Firstly, considering the flow of income and expenditure between household sector and
the government, household sector pays income tax and commodity tax to the government. On
the other hand, the government also makes transfer payments to the household sector in the
form of various benefits and services like pension funds, relief, sickness benefits, health,
education, and other services.
The flow of income and expenditure between the business sector and the
government is similar. Business firms pay taxes to the government, the government, on the
other hand, provides subsidies, makes transfer payments, and pays for the goods and services it
purchases from the business sector.
As stated earlier, taxes paid by the household and the business sector are the
leakages from the circular flow. This decreases not only the consumption and savings of the
household sector but also investments and production of the business sector decrease.
However, the government offsets the leakages by buying services from the household
sector, and goods and services from the business sector. This leads to equilibrium in the circular
flow as the level of demand meets the level of supply in the economy.
A part of the income earned by the government is saved and deposited in the capital
market. The government also takes loans from the capital market either to meet the current
expenditure or to invest in different projects.

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Assumptions
 The economy consists of household ,business, and government sector
 There is government intervention
 Government imposes taxes and grants subsidies
 There is perfectly competitive market
 The economy has no international trade
 Business sector pay both direct and indirect tax to the government
 Households sector pays only direct tax to the government

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 The Circular Flow of Income and Expenditure in the Three Sector
Economy

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Circular Flow of Income and Expenditure-Four Sector Economy
The circular flow model in four sector economy provides a realistic picture of the circular
flow in an economy. Four sector model studies the circular flow in an open economy which
comprises of the household sector, business sector, government sector, and foreign sector.
The foreign sector has an important role in the economy. When the domestic business
firms export goods and services to the foreign markets, injections are made into the circular
flow model. On the other hand, when the domestic households, firms or the government
imports something from the foreign sector, leakage occurs in the circular flow model.

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Circular Flow of income and Expenditure in Four sector economy

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 From the viewpoint of the circular flow of income, each sector has dual roles to play
in the economy; while a sector receives certain payments from other sectors, it pays back to
those sectors as well. The circular flow of income in different sectors can be expressed as
follows:
Household Sector
Receipts
The household sector receives factor income in the form of rent, wages, interest, and
profit from the business sector. It also receives transfer payments from the government
sector.
Payments
The income of the household sector flows into the business sector, government sector and
capital markets in the form of consumption expenditure, taxes and savings respectively.
Business Sector
Receipts
The principle receipts of the business sector constitute of income from the sale of goods
and services, income from exports, subsidies from the government sector, and borrowings
from the capital market.
Payments
Factor payments, import payments, and savings constitute the principal payments from
the business sector to the household sector, government sector, foreign sector and the
capital market.
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Government Sector
Receipts
The major source of income for the government sector includes the taxes paid by
household and business sector. Besides this, it also receives interests and dividends for the
investments made.
Payments
The government sectors make payments to different sectors in the form of transfer
payments, subsidies, grants, etc. It pays to the business sector in return for the goods
purchased; makes transfer payments like pension funds, scholarships, etc. to the household
sector. If the government receipts are greater than the expenses, the surplus goes to capital
market. In case of cash deficit, the government borrows from the capital market to maintain
a balance in the economy.
Foreign Sector
Receipts
The foreign sector receives income from the business sector in return for the goods and
services imported by the latter.
Payments
Foreign sectors need to make payment to the business sector from where imports have
been made.
If exports exceed imports, the economy has a surplus balance of payment. In case exports
exceed imports, the economy faces a deficit balance of payment. Depending on the trade
policies, the economy tries to maintain a balance between imports and exports.
Capital Market
Household, business, and government sectors deposit their excess of income to the
capital markets as savings. These savings are borrowed by the business sector or government
sector for making investments in different projects.

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National Income
National income is an uncertain term which is used interchangeably with
national dividend, national output and national expenditure. On this basis,
national income has been defined in a number of ways. In common parlance,
national income means the total value of goods and services produced annually
in a country. National Income refers to the money value of all the goods and
services produced in a country during a financial year. In other words, the final
outcome of all the economic activities of the nation during a period of one year,
valued in terms of money is called as a National income.
In the above definition, the economic activities include all the human
activities that produce goods and services that can be valued at market price.
Such as production by farmers, production by firms in different industrial
sectors, production of goods and services by government, services produced by
business intermediaries Viz. Wholesalers and retailers, banks and other financial
institutions, educational institutes and professionals like doctors, teachers,
lawyers, etc.

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Contd……………
Also, there are non-economic activities that include the production of
goods and services but do not have any market value. Such as hobbies, services
of housewives, service to self, an exchange of mutual service between
neighbors, etc.
The National Income is a vital macroeconomic variabl e which determines
the business level and economic status of the nation. The level of national
income determines the aggregate demand of goods and services while its
distribution defines the pattern of aggregate demand, i.e., what kinds of goods
and services are produced and demanded.
The economic activities that generate a large number of goods and
services in the country constitute the national income of a closed economy,
where no economic transactions with the rest of the world are taken into
consideration. While in the case of an open economy, the national income
includes the economic transactions with the rest of the world.
While the economic activities generate the flow of goods and services, it
also generates the money flows in the form of factor payments, such as wage,
rent, interest, earnings of the self-employed. Thus, national income can also be
estimated by adding all the factor earnings and adjusting the sum of subsidies
and the indirect taxes. Thus, the income obtained is called as a National income
at factor Cost, related to the money flows.
In other words, the total amount of income accruing to a country from
economic activities in a year’s time is known as national income. It includes
payments made to all resources in the form of wages, interest, rent and profits.

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Definition of National Income
“The labor and capital of country acting on its natural resources produce annually a
certain net aggregate of commodities, material and immaterial including services of all kinds.
This is the true net annual income or revenue of the country or national dividend.”
------Alfred Marshall
“National income is that part of objective income of the community, including of
course income derived from abroad which can be measured in money.”
--------A.C.pigou
“The National dividend or income consists solely of services as received by ultimate
consumers, whether from their material or from the human environments. Thus, a piano, or
an overcoat made for me this year is not a part of this year’s income, but an addition to the
capital. Only the services rendered to me during this year by these things are income.”
-------Irving Fisher
“National income is the net output of commodities and services flowing during the
year from the country’s productive system in the hands of the ultimate consumers.”
--------Simon Kuznet
On the other hand, in one of the reports of United Nations, national income has
been defined on the basis of the systems of estimating national income, as net national
product, as addition to the shares of different factors, and as net national expenditure in a
country in a year’s time. In practice, while estimating national income, any of these three
definitions may be adopted, because the same national income would be derived, if different
items were correctly included in the estimate.

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Different Concepts of National Income
 Gross Domestic Product-GDP
 Gross National Product-GNP
 Net National Product-NNP
 National Income-NI
 Personal Income-PI
 Disposable Income-DI
 Per Capita Income-PCI
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Gross Domestic Product - GDP
Gross domestic product (GDP) is the monetary value of all the finished
goods and services produced within a country's borders in a specific time
period. Though GDP is usually calculated on an annual basis, it can be
calculated on a quarterly basis as well. The market value of all final goods
and services produced within the domestic territory of a country during a
year is called GDP .It includes:
 Currently produced goods and services
 Final products
 Goods and services produced with in the economy
 Market value of output
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The Significance of GDP
GDP is commonly used as an indicator of the economic health of a
country, as well as a gauge of a country's standard of living. Since the mode
of measuring GDP is uniform from country to country, GDP can be used to
compare the productivity of various countries with a high degree of
accuracy. Adjusting for inflation from year to year allows for the seamless
comparison of current GDP measurements with measurements from
previous years or quarters. In this way, a nation’s GDP from any period can
be measured as a percentage relative to previous periods. An important
statistic that indicates whether an economy is expanding or contracting,
GDP can be tracked over long spans of time and used in measuring a
nation’s economic growth or decline, as well as in determining if an
economy is in recession (generally defined as two consecutive quarters of
negative GDP growth).

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Calculation of GDP
Product method
GDP = P1× Q1 + P2 × Q2 +---------------------+ Pn × Qn+ (X-M)
Where,
P = Per. unit price
Q = Quantity produced
X-M = Net Export; X = Export, M = Import
Income Method
GDP = w + i + r + π + (X-M)
Where,
W =Wage
I= Rate of Interest
r= rent
π= Profit
X-M = Net Export; X = Export, M = Import
Expenditure Method
GDP = C + I+ G + (X-M)
Where,
C= Consumption Expenditure
I = Investment Expenditure
G = Government Expenditure
X-M = Net Export; X = Export, M = Import

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GDP at Market Price and GDP at Factor Cost
GDP measured at the actual market price which either the consumers or producers pay for the
purchase of goods and services whether for consumption or investment is called GDP at market price. If
GDP is measured as the sum of price paid to the all factors of production of wage, profit, Interest and
rent for their contribution in production, it is known as the GDP at factor cost. In order to calculate GDP
at factor cost, we have to deduct the net indirect taxes from GDP at market price.Net indirect tax is
equal to indirect tax minus subsides.

GDP at MP = P1× Q1 + P2 × Q2 +---------------------+ Pn × Qn

GDP at FC = GDP at MP – Net indirect Taxes

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Nominal GDP, Real GDP, and Price Level
Nominal GDP is GDP evaluated at current market prices. Therefore, nominal GDP
will include all of the changes in market prices that have occurred during the current year due
to inflation or deflation. Inflation is defined as a rise in the overall price level, and deflation is
defined as a fall in the overall price level. In order to abstract from changes in the overall
price level, another measure of GDP called real GDP is often used. Real GDP is GDP evaluated
at the market prices of some base year. For example, if 1990 were chosen as the base year,
then real GDP for 1995 is calculated by taking the quantities of all goods and services
purchased in 1995 and multiplying them by their 1990 prices.
GDP deflator
Using the statistics on real GDP and nominal GDP, one can calculate an implicit index
of the price level for the year. This index is called the GDP deflator and is given by the formula

The GDP deflator can be viewed as a conversion factor that transforms real GDP into
nominal GDP. Note that in the base year, real GDP is by definition equal to nominal GDP so
that the GDP deflator in the base year is always equal to 100.GDP at FC = GDP at MP – Net
indirect Taxes.

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Gross National Product-GNP
Gross national product (GNP) is the market value of all the goods and
services produced in one year by labor and property supplied by the citizens of a
country. Unlike gross domestic product (GDP), which defines production based on
the geographical location of production, GNP indicates allocated production
based on location of ownership. In fact it calculates income by the location of
ownership and residence, and so its name is also the less ambiguous gross
national income. GNP is an economic statistic that is equal to GDP plus any
income earned by residents from overseas investments minus income earned
within the domestic economy by overseas residents.
Gross national product (GNP) is an estimate of total value of all the
final products and services turned out in a given period by the means of
production owned by a country's residents. GNP is commonly calculated by taking
the sum of personal consumption expenditures, private domestic investment,
government expenditure, net exports and any income earned by residents from
overseas investments, minus income earned within the domestic economy by
foreign residents. Net exports represent the difference between what a country
exports minus any imports of goods and services.
GNPMP = GDPMP + NFIA

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Features of GNP
 It is calculated in monetary terms
 It includes only final goods and services
 The intermediate goods are excluded to avoid double counting
 It includes income earned by the residents of a country within a
country and abroad
 It does not include capital gains and transfer payments.
 It includes only those goods which have market value and
brought in the market for sale.

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Net National Product –NNP
Net national product is the sum of net product of goods and services during the year in
the economy. To calculate the national product capital consumption allowance or
depreciation should be deducted from the value of GDP .While producing goods and services,
the machineries and other fixed capitals wear and tear .It is known as deprecation. By the
deducting the value of depreciation from the value of gross national product in a year, we get
the value of net national product.
Thus,
NNP = GNP - Depreciation

NNP at MP and NNP at FC

NNP measured at the actual market price is called NNP at market price whereas NNP
measured as the sum of price paid to the all factors of production in form of wages, profit,
interest and rent for their contribution in production is called NNP at factor cost. In order to
calculate NNP at factor cost, we deduct net indirect tax from NNP at MP.

NNP at FC = NNP at MP - Net Indirect Tax

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National Income-NI
National income is also called net national product at factor cost .It
measures the total income received by factors of production .Here national
income is calculated on the basis of remuneration of factors production
.Therefore, the sum of income received by all factors of production in the form
of rent, wages, interest and profits is known as national income .When indirect
taxes are deducted from NNP with the addition of subsidies, we will get national
income. National income can be calculated by following formula:
NI = NNP- Indirect Taxes + Subsidies
NI=NNP at FC

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Personal Income-PI
The total income received by all individuals and households of a country from all
possible sources before payment of direct taxes during a year is called personal income.
While calculating personal income, social security contribution (SSC), corporate income tax
(CIT), and undistributed corporate profit is deducted from NI and transfer payment is added
in PI.

PI = NI - UCP – SSC – CIT + TP

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Disposable Income -DI
Whatever be the income remains after the payment of direct taxes from personal
income is known as disposable income. Personal disposable income refers to those parts of
personal income, which is actually available to individuals to consumption. All personal
income may not be available for being spent in satisfying needs. Individual have to pay
certain direct taxes such as income tax, wealth tax, estate tax etc. Hence the personal
disposable income is personal income minus personal direct taxes, fee and fines etc.
DI = PI – DT
Where,
DI = Disposable Income
PI = Personal Income
DT = Direct Taxes

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Per Capita Income-PCI
The average income of the people of a country in a particular year is called
per capita income. It is expressed at the current prices. In order to find the per
capita income, national income of the country in a particular year is divided by
population of the country in that year Per Capita Income for 2017 = National
Income for 2017/Total Population for 2017
The per capita income concept enables us to know average income and
living standard of the people. It is one of the important indicators of economic
development of the country. But it is not very reliable, because in every country
due to unequal distribution of national income,a major part of it goes to the
richer sections of the society and thus income received by common people is
lower than the per capita income.
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Measurement of National Income
Product Method
 Final Product Method
 Value Added Method
Income Method
Expenditure Method

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Product/Value Added Method
The value added method/ product method is also known as the output
method or inventory method. In this method, the sum total of the gross value of
the final goods and services in different sectors of the economy like industry,
service, agriculture, etc. is acquired for the current year by determining the total
production that was made during the specific time period. The value obtained is
the gross domestic product. Thus, according to this method,
GDP= Total product of (industry + service + agriculture) sector
Symbolically, GDP= ∑ (P × Q)
Where,
P= Market price of goods and services
Q= Total volume of Output
Sometimes goods produced by one sector are further processed by another
sector. These goods are termed as intermediate goods and are already included
while determining the value of final goods.
So, in order to avoid the problem of double counting of value of goods, the
product method if further categorized into two approaches:

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The Final Goods Approach
In this method, only the value of final goods and services are computed
while estimating GDP, regardless of any intermediate goods and their
processing. This method takes into account only those goods and services that
purchased and consumed by the final consumers in the economy.
The Value Added Method
In the value added method of measuring national income, the value of
materials added by producers at each stage of production to produce the final
good is considered. The difference between the value of output and inputs at
each stage of production is the value added. Thus,
Value added= Value of output – Cost of intermediate goods
If the differences are added up for all production sectors in the economy, the
value of GDP is computed.
Estimation of National Income by Value Added Method
Producer Stage V.O C.I G.V
Farmer Wheat 600 60
Miller Flour 90 60 30
Baker Bread 100 90 10
Total 250 150 100

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Product Method
Product method is also known as output method or value added method. In this method, we
calculate the national income in terms of final goods and services produced in an economy during a
particular period of time. The final goods are those which are either available to the consumers for
consumption or become a part of national wealth in the form of investment.
Definition
Product method is that which estimates the national income by measuring the contribution of final
output and services by each producing enterprise in the domestic territory of a country during a
given accounting period.

Steps in Product Method

Classification of Productive Enterprises
The first step in this method of measuring national income is the classification of enterprises. All
the productive enterprises in the economy are classified into three main categories, viz. (i) Primary
Sector, (ii) Secondary Sector and (iii) Tertiary Sector. Let us briefly explain these sectors.

(i) Primary Sector – Primary sector refers to that sector of the economy which exploits natural
resources to produce goods. Agriculture and allied activities like mining, quarrying, fishing,
forestry etc. are included in this sector.
(ii) Secondary Sector – The manufacturing sector of the economy which transforms one physical
good into another is included in the secondary sector.
(iii) Tertiary Sector – Primary sector refers to that sector of the economy is known as the tertiary
sector. This includes banking, insurance, education, trade, commerce etc.

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Classification of Output
National output is classified into the following types:

(i) Consumer Goods – Consumer goods are those goods which help in the further production of
consumer gods. These are also called are also called capital goods.
(ii) Producer Goods- Producer gods are those goods which help in the further production of
consumer gods. These are also called capital gods.
(iii) Govt. Produced Goods- These include defence, police, education, health care, roads, railways,
ports, dams etc.
(iv) Net Exports- Net exports refer to the value of goods and services exported to the rest of the
world minus the value of goods & services imported during an accounting year.
Step III.
Measurement of Value of Output
There are two methods of measuring the value of output. They are (i) Final output method, (ii)
Value added method. Below we discuss these two approaches of product method of measuring
national income.
(i) Final Output Method
In final method, we have to estimate the following element involved to arrive at the correct figure of
the final output.
(a) Value of output
Here output means final goods as well as intermediate goods. The value of all these goods can be
estimated by multiplying the quantity of output of each producing unit with the market price. This
is equal to the value of sales and the change in stock.
(b) Value of intermediate consumption
The goods and services used by the firms as inputs are known as intermediate consumption. To
calculate the value of intermediate consumption, we have to multiply the intermediate goods with
the prices paid by the enterprises to purchase these goods.

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(C) Consumption of fixed capital
Consumption of fixed capital means depreciation. When goods are produced, there is wear and tear
of machines leading to the loss of value of the capital assets. To calculate this loss of value in an
accounting period, we have to deduct the value of capital asset at the end of the period from the
value of the asset at the beginning of the period.

According to final output method, the value of intermediate goods is deducted from the value of
output. The quantity produced by each producing enterprise is multiplied by the market price. This
gives us the value of output. From this, we deduct the value of intermediate consumption to arrive
at the value of the output.

Value of final output= Value of output- Value of intermediate goods

When we add the market value of final output in the primary sector, secondary sector and that of
tertiary sector, we arrive at gross domestic product at market price.

GDP at Market Price = Market value of final output of primary sector +

Market value of final output of tertiary sector
By deducting depreciation from GDP at market price we can get net domestic product at market
price. When we add net factor income from abroad, we get GNP and NNP at market price.

Net Domestic Product at Market Price = Gross Domestic Product at Market Price-Depreciation
(ii) Value Added Method:
Value added refers to the addition of value of intermediate goods in the process of production. To
estimate the national income through value added approach, we have to add the value added in
each producing enterprise within the domestic territory of a country.

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Definition
Value added method is that method which measures the contribution of each producing enterprise
to production in the domestic territory of the country.

Step Involved in the Method

Step1. Identification and Classification of Enterprises
The first step involved in this method is to identify and classify the productive enterprises. As said
earlier we can classify these enterprises into three bro ad categories, viz. (a) Primary Sector, (b)
Secondary Sector, (c) Tertiary Sector.

Step II. Estimation

The second step involved is the estimation of value added. For this purpose we have to calculate the
value of output and value of intermediate consumption. This method is adopted to avoid the
problem of double counting. In order to estimate the value added by a productive enterprise, the
value of intermediate good is deducted from the value of total output of the productive enterprise.

Value Added = Value of Output – Value of Intermediate Goods

Step III
The third step in the estimation of national income is to add up the gross value added by all the
producing units across three sectors of the economy. This gives us the gross domestic product at
market price. To obtain the net value added, the value of depreciation has to be deducted from the
gross value added at market price. Thus we can arrive at the net domestic product at market price.
To calculate the net national income, we have to add up the net factor income from abroad with the
net domestic product.

Precautions to be taken
1. The transactions of second hand goods are not to be included.
2. Commission earned in the transaction of second hand goods by the commission agents is
included in the estimation of value added.
3. Value of intermediate goods like raw materials, semi-finished goods is not to be included.
4. Illegal activities like smuggling, gambling etc. are excluded in the calculation of value added.
5. Service of housewives are excluded.
6. Imputed value of the product kept for self-consumption should be taken into account.
7. Imputed rent of owner-occupied dwellings has to be included.
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Income Method
The income approach to measuring gross domestic
product (GDP) is based on the accounting reality that all
expenditures in an economy should equal the total income
generated by the production of all economic goods and
services. It also assumes that there are four major factors of
production in an economy and that all revenues must go to one
of these four sources. Therefore, by adding all of the sources of
income together, a quick estimate can be made of the total
productive value of economic activity over a period.
Adjustments must then be made for taxes, depreciation, and
foreign factor payments.
Income Method measures national income from the
perspective of factor incomes. Under this method, incomes
received by all the residents of a country for their productive
services during a year are added up to obtain the national
income.

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According to this method, all the incomes that accrue to the
factors of production by way of wages, profits, rent, interest,
etc. are summed up to obtain the national income. Income
method is also known as ‘Distributive Share Method’ or ‘Factor
Payment Method’.
This method approaches national income from distribution
side. In other words, this method measures national income at
the phase of distribution and appears as income paid and or
received by individuals of the country. Thus, under this method,
national income is obtained by summing up of the incomes of
all individuals of a country. Individuals earn incomes by
contributing their own services and the services of their
property such as land and capital to the national production.

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 Therefore, national income is calculated by adding up
the rent of land, wages and salaries of employees, interest on
capital, profits of entrepreneurs (including undistributed
corporate profits) and incomes of self-employed people. This
method of estimating national income has the great advantage
of indicating the distribution of national income among
different income groups such as landlords, owners of capital,
workers, entrepreneurs.

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Difficulties in Measurement of National Income
 Double Counting
 Calculation of Depreciation
 Change in Value of Money
 Illegal Income
 Inadequate and Unreliable Data
 Choice of Method
 Unreported Illegal Income
 Intermediate goods
 Existence of Non-monetized Sector
 Value of Public Services

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Importance of National Income Accounting
 Indicator of Economic Structure
 Indicator of Economic Welfare and International Comparison
 Helpful to Formulate Economic Policy and Planning
 Inflationary and Deflationary Gape
 Basis of Budgetary Policies
 Importance in Defense and Development
 Provision of Depreciation
 Importance in Development Countries
 Basis of Social Accounting
 Importance in Economics Analysis

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Measurement Difficulties of National Income

A number of difficulties arise in measuring the national income accurately. National income accounting
involves both conceptual as well as statistical difficulties.

A. Conceptual Difficulties

The conceptual difficulties in measuring national income include:

Problem of Definition

The major problem arises when defining the composition of national income. Ideally, national income
includes all the goods and services produced within a certain time period. But there are times when it is
difficult to decide which goods to include and which to exclude. A clear distinction between finished goods
and intermediate goods is difficult.

For instance, the paper used as office stationery is a final product, but if the paper is used in a book, it
becomes an intermediate product.

Price Changes

Change in price is one of the greatest challenges in computing national income. The continued change in
the price of raw materials, production process, and the final goods make it difficult to get determine the
actual cost of the goods and services when they arrive at the market.

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Double Counting

Double counting is an issue that is most prominent while determining national income. It refers to the
counting the value of a good more than once.

For instance, a woodcutter sells a log of wood at 2 dollars to a carpenter. The latter makes a table of it
and sells it to a furniture vendor at 4 dollars. Now if the price of wood is counted every time then, national
income increases by 6 dollars whereas the actual increase is only 4 dollars i.e. the final price of the final
product.

The problem of inaccuracy is seen when the value of national income is inflated due to double counting.
So, only the value of final good should be taken into account to estimate the national income accurately.

Income from Foreign Investors

This problem arises especially with countries where MNCs reside. Although MNCs are doing well in the
host country, a part of their total income goes to the mother company located in a foreign land. So, the
actual national income of the host country for the current year cannot be accurately determined.

Services rendered with no Accountability

Another major problem in computing national income is the inclusion of non-monetary transactions that
are carried out within an economy. Although the transactions are carried out within the economy, they are
not recorded with monetary value. This reduces the overall income of a nation.

For instance, the household work carried out by women are not for commercial purpose and are not
considered in monetary terms while calculating national income.

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B. Statistical Difficulties

The statistical difficulties are mostly seen in the developing as well as under-developed countries. Some
of the statistical difficulties in measuring national income include:

Unrealistic and Inadequate Statistics

Especially in the underdeveloped and developing countries, it is difficult to obtain statistics due to the
problem of illiteracy. No proper accounts are maintained for production or expenditure. Besides this,
producers provide fabricate data in order to evade income tax. Due to these reasons, the true picture of
national income cannot be obtained.

Existence of Barter System

Even in the modern era, barter system continues to exist in the backward communities. People exchange
goods for goods and service are paid in kind. No transactions are not carried out in monetary terms.
Under these circumstances, a correct estimate of national income is not possible.

The Underground Economy

The underground economy exists in any economy. This includes illegal activities like gambling,
smuggling, drugs, etc. These illegal forms of economic activity are not reported to the authority for tax
purpose and are excluded from national income accounts

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Self-consumed Production

Economies in developing countries are involved in producing goods and services for self-consumption
rather for commercial selling. Usually, some parts of the produced goods are either consumed by the
producer themselves or bartered for some other goods with consumers and other entities in the market.
This non-monetised sector makes it difficult to calculate national income.

Lack of Occupational Classification

People in under-developed countries engage themselves in one or more occupations to earn their
livelihood. There is no clear-cut division of occupations and it is very difficult to identify the incomes of the
individuals from a specific job or other occupational undertakings.

Lack of Common Denominators

The numerous economic activities undertaken by individuals, business firms, and governmental bodies
cannot be reduced to a common measurable denominator.

For instance, the income earned by the mayor of a state cannot be measured in same terms as that of a
vegetable vendor. This is one of the reasons why national income accounting is not able to determine the
true picture of how an economy is functioning.

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Numerical Example-I
Calculate GDP at MP, GNP at MP, NNP at MP and NI from the following data.

Components of NI R.s in Core

Intermediate Consumption of
Primary Sector 500

Secondary Sector
400
Tertiary Sector
300

Value of Output of
Primary Sector 1000

Secondary Sector 900

Tertiary Sector 700

Net Factor Income from Abroad -20
Consumption of Fixed Capital (Dep.) 40
Net Indirect Taxes 10
(1400, 1380, 1340, 1330)

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Numerical Example-III
Consider the following table and calculate NI by income and expenditure method.
Items R.s. In core
Mixed income 400
Compensation of employees 500
Private final consumption expenditure 900
Net factor income from abroad -20

Net indirect taxes 100

Consumption of fixed capital 120
Net domestic capital formation 280
Net export -30
Profit 350
Rent 100
Interest 150
Government final consumption 450
expenditure
(1480)

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Numerical Example-II
Calculate the GDPMP, NI, PI and DI from the Following (R.s in Million)
Personal tax paid 220
Interest paid by business 20
NFIA 60
Retained earnings(UCP) 60
Wages and salaries 1000
Provision for pensions 100
Social security contribution 50
Bonus 200
Corporate income tax 80
Rent paid 50
Mixed income 1500
Indirect tax 300
Subsidies 100
Depreciation 250
Dividend Paid 40
Transfer payment 150
(3450, 3060, 3020, 2800)

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