Friday, 27 May 2011

NATIONAL INCOME : Business Economics 1st Year

            After going through this chapter, you should be able to
·         Understand the concept of National Income
·         Know the methods of measuring national income
·         Know the difficulties in calculating national income

8.1.      Definition of National Income
            8.1.1   Methods of measuring National Income
            8.1.2   Difficulties in calculating National Income
            Unit Questions

8.1.   National Income-Definition
            The concept of national income occupies and important place in economic theory.  National income is the flow of goods and services produced in an economy over a period of one year.
            Marshal has defined national income as “The labour and capital of a country acting upon its natural resources, produce annually a certain net aggregate of commodities material and immaterial including services of all kinds”.

8.1.1   MethodS of Measuring National Income
Census of Production Method
            This method is popular in U.S.A. and is called as Total Product Method or Goods Flow Method.  In India, it is known as Inventory or Product Method.  In this method, the economy is classified into three sectors-the industrial sector, direct services sector and foreign transaction sector where international payments are considered.  Industrial sector includes all productive activities.  It includes the flow of goods in different fields like agriculture, mining, transport and public utilities.  In order to avoid double counting, value added method can be followed. In following value added method, any commodity which is a raw material for another industry should not be included.  Only the value added at each stage of production should be considered.   For example, in farming operations, the cost of seeds, fertilisers etc., are to be deducted.  Thus the product census gives GNP from which if depreciation is deducted, NNP can be obtained.

            In the direct services sector, the value of services which directly serve the consumers is taken into account.  Dramatists, professors, doctors come under this category. All types of salary payments are included.  Pensions are transfer payments and they are excluded.  Houses render a service.  Hence rental values have to be included.

            In the international transaction sector, value of exports and imports, payments from abroad and payments to other countries are taken into account.

            When the incomes from all these sectors are added, national income at market price is obtained.  The National Income Committee of India adopted Census of Production Method along with Income Method to estimate national income. This method helps to have a comparative idea of the importance of various activities like agriculture, manufacturing, transport and trade in generating national income.  However, in an advanced country like U.S.A., this method may be successful as it is very easy to get data from records. But in under developed countries like India, this method may give rise to many problems like imputation of money values to large non-monetised sector. 

Income Method :
            GNP consists of the sum of factor earnings, wages, salaries, rent, interest earnings, dividends earned by the shareholders. Profits which are not distributed by companies, taxes on individuals, corporations and other businesses are also included in GNP.  Income from indirect taxes like excise duties and sales tax, depreciation allowance made by corporations are also added in GNP.  The difference between exports and imports is also added.

            GNP=Wages and Salaries + Rents + Interest + Dividends + Undistributed Corporate Profits + Mixed Incomes + Direct Taxes + Indirect Taxes + Depreciation + Net Income from abroad.

            Expenditure Method : Prof. Samuelson calls this as ‘Flow of Product Approach’. In India, it is known as Outlay Method. GNP is the sum of expenditure incurred on goods and services during one year in a country.  In includes personal consumption expenditure of individuals on durable goods, consumer goods and expenditure on services.  It also includes expenditure on new investment, on replacement of old capital and inventory or raw materials, manufactured and semi-manufactured goods.

            The government expenditure on goods and services is also a part of GNP. Central, State and Local governments spend lot of money on their employees, police, army and on government enterprises.  The difference between exports and imports should also be included in GNP.

            GNP= Private Consumption Expenditure (C) + Private Investment Expenditure (I) + Government Expenditure (G) + Net Foreign Investment
(X-M) C+I+G+(M-M)    

Value Added Method :
            In order to avoid double counting value added at each stage of production should be calculated to arrive at GNP. The difference between the value of output and input at each stage of production is called the value added.  By summing such value added for all industries in the economy, GNP can be found out.

            Whatever may be the method used, the result should be more or less the same.  All the three methods can be used to cross check the reliability of estimates.  But, no country has perfected national income accounting to such an extent to get exactly similar figures.  They make use of two or three methods to give more accuracy.

8.1.2   Difficulties in Calculating National Income
            The presentation of national income accounts appears to be simple. But there are certain practical difficulties-conceptual and statistical.  But they are not insurmountable.

1.         Simon Kuznets mentions some theoretical difficulties in the estimation of the term ‘nation’ in national income.  National income is not limited to the territorial boundaries of country.  We must include income of all the residents of a country even if they are abroad.  Therefore, income produced within a country and any income earned abroad have to be included in national income.

2.         The second difficulty is to decide about the nature of goods and services to be included in national income.  It is now accepted that the value of final goods and services should be taken into account.  In order to avoid double counting, value added method can be used.  Similarly, if there is non-monetised sector, money value has to be imputed for goods and services.

3.         Income earned through illegal activities is not included in national incomes.  This results in a diminution of national income.

4.         Services rendered free of charge are not included in GNP. By leaving out these services., national income will work out to be less.

5.         Transfer payments are not included in national income as they do not contribute to national product.

6.         Capital gains and losses are not included in GNP as they are not the result of current economic activities.

7.         Changes in price level also make the calculation of national income difficult.  National income figures show an increase when the price level rises, even though the production might have fallen.  On the contrary, with a fall in price level, the national income shows a decline even though production might have gone up. Therefore, national income cannot be calculated accurately due to price changes.    

8.         In the calculation of national income, leisure foregone in the process of production is not included.  For example, incomes of two individuals may be same but the hours of work may be different.  Similarly, working conditions may be poor. Therefore, while calculating national income, these have to be considered.

9.         Another difficulty arises with regard to public services rendered by the government.  In the days of war, the military forces are active but during peace they take rest.  In this case, value of the services rendered by military forces cannot be estimated. Similarly, it is difficult to estimate the value of administrative services, justices etc., that are performed by the government.

            In underdeveloped countries, there are some special difficulties in estimating national income.

1.         A very great difficulty in estimating national income in underdeveloped countries is the prevalence of non-monetised sector. A considerable portion of the output does not come to the market. Agriculture is still in a state of subsistance farming and therefore a major part of the output is consumed in the farm itself or exchanged for other commodities.  This gives rise to the problem of imputation of money values.

2.         In underdeveloped countries, due to illiteracy, most producers do not keep regular accounts.  They do not have any idea about the expenditures incurred in production. In the urban areas too, educated people also hesitate to disclose their accounts.  Hence, it is difficult to estimate national income.

3.         Further, it becomes difficult to know income by origin because there is lack of occupational specialisation. An agricultural labourer works as a coolie or riksha puller during off-season. Therefore, due to overlaping of occupations it is difficult to estimate national income.

4.         Another difficulty in the estimation of national income in underdeveloped countries arises due to scattered and unorganised productive activities.  It is also difficult to find out the output produced be self-employed agriculturists, small producers and owners of household enterprises in unorganised sector.

5.         The greatest difficulty in the measurement of national income in underdeveloped countries is lack of adequate statistical data. Inadequacy, non-availability and unrealiability of statistical data is a great handicap in measuring national income in these countries.  Statistical information regarding agriculture and allied occupations, and household enterprises is not available.  Even the statistical information regarding the enterprises in the organised sector is unreliable. There is no accurate information available regarding consumption, investment expenditure and savings of either rural or urban population.  

Unit QuestionS
1.         Define national Income and explain the methods of measuring national    Income.
2.         Give an account of the difficulties involved in the measurement of national          income.  

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