Syllabus- National Income -Concepts and Measurement of National Income- Nominal and Real Income.
Number of questions- Mains: 02, Prelims – 10
Mains Questions of the day-
1.What is national income and why is it calculated? Explain the three main methods of computing national income?
Introduction:
Define the National Income
Body:
- Mention the importance of National Income measurement
- Mention the Methods of calculating National Income.
Conclusion:
Explain the various advantages of calculating national income – in policy formulation, effective decision making and for making international economic comparisons etc.
Content:
- National income is the sum of total value of all final goods and services produced in a country during one financial year.
- Computation of National Income is very vital as it indicates the overall health of our economy for that particular year.
- The economic performance of a nation is calculated with the help of National income data.
- The basic purpose of national income is to know about aggregate output and income and provide a basis for the government to formulate its policy, programs, to maximize the national welfare of the people.
- National Statistics Office calculates the National Income in India.
Methods for measuring National Income:
The three main methods of computing national income –
- Income method,
- Expenditure method and
- Output method.
- Income Method:
- In this method, we add net income payments received by all citizens of a country in a particular year.
- Net incomes that result in all the factors of production like net rents, wages, interest, and profits are all added together.
- But income received in the form of transfer payments are omitted.
- Output Method:
- This method measures the national income either
- By taking the market value of final goods and services produced in an economy during an accounting year or
- By estimating the contribution made by each of the producing units in the economy to the total production within the domestic territory during an accounting year.
- There are two methods of measuring national income by the output method.
- The final goods method: This method measures the national income by taking the market value of final goods and services produced in an economy during an accounting year.
- The value added method: The value added method measures the national income by estimating the contribution made by each of the producing units in the economy to the total production within the domestic territory during an accounting year.
- Expenditure Method:
- The total expenditure by a society in a financial year is summed up together and includes personal consumption expenditure, net domestic investment, government expenditure on goods and services, and net foreign investment.
- This concept is backed by the assumption that national income is equal to national expenditure.
Importance of National Income:
- Setting Economic Policy:
- National Income indicates the status of the economy and can give a clear picture of the country’s economic growth.
- National Income statistics can help economists in formulating economic policies for economic development.
- Inflation and Deflationary Gaps
- For timely anti-inflationary and deflationary policies, we need aggregate data of national income.
- If expenditure increases from the total output, it shows inflammatory gaps and vice versa.
- Budget Preparation
- The budget of the country is highly dependent on the net national income and its concepts.
- The Government formulates the yearly budget with the help of national income statistics in order to avoid any cynical policies.
- Standard of Living:
National income data assists the government in comparing the standard of living amongst countries and people living in the same country at different times.
- Defence and Development
- National income estimates help us to calculate the national product for defence and the national product for development purposes of the country.
- From such figures, we can easily know, how much can be set aside for the defence budget.
2.Explain the problems while calculating of national Income.
Introduction:
Define national income
Body:
Briefly mention various methods of calculating National Income and problems while calculating National Income.
Conclusion:
Write some suggestions to overcome the challenges in calculating national income accounting.
Content:
- National income is the sum of total value of all final goods and services produced in a country during one financial year.
- Computation of National Income is very vital as it indicates the overall health of our economy for that particular year.
- The economic performance of a nation is calculated with the help of National income data.
- The basic purpose of national income is to know about aggregate output and income and provide a basis for the government to formulate its policy, programs, to maximize the national welfare of the people.
- National Statistical Office calculates the National Income in India.
Methods for measuring National Income:
The three main methods of computing national income –
- Income method
- Expenditure method
- Output method
Problems in Income Method:
The following problems arise in the computation of National Income by income method:
- Owner-occupied Houses:
- A person who rents a house to another, earns rental income
- But if he occupies the house himself, will the services of the house-owner be included in national income.
- The services of the owner-occupied house are included in national income as if the owner sells to himself as a tenant its services.
- Self-employed Persons:
- Another problem arises with regard to the income of self-employed persons.
- In their case, it is very difficult to find out the different inputs provided by the owner himself.
- He might be contributing his capital, land, labour and his abilities in the business.
- But it is not possible to estimate the value of each factor input to production.
- So he gets a mixed income consisting of interest, rent, wage and profits for his factor services.
- This is included in national income.
- Goods meant for Self-consumption:
- In under-developed countries like India, farmers keep a large portion of food and other goods produced on the farm for self-consumption.
- The problem is whether that part of the produce which is not sold in the market can be included in national income or not.
- If the farmer were to sell his entire produce in the market, he will have to buy what he needs for self-consumption out of his money income.
- If instead he keeps some produce for his self-consumption, it has money value which must be included in national income.
- Wages and Salaries paid in Kind:
- Another problem arises with regard to wages and salaries paid in kind to the employees in the form of free food, lodging, dress and other amenities.
- Payments in kind by employers are included in national income.
- This is because the employees would have received money income equal to the value of free food, lodging, etc. from the employer and spent the same in paying for food, lodging, etc.
Problems in output Method:
The following problems arise in the computation of national income by product method:
- Services of Housewives:
- A housewife renders a number of useful services like preparation of meals, serving, tailoring, mending, washing, cleaning, bringing up children, etc.
- She is not paid for them and her services are not including in national income.
- Such services performed by paid servants are included in national income.
- The national income is, therefore, underestimated by excluding the services of a housewife.
- Intermediate and Final Goods:
- The greatest difficulty in estimating national income by product method is the failure to distinguish properly between intermediate and final goods.
- There is always the possibility of including a good or service more than once, whereas only final goods are included in national income estimates.
- This leads to the problem of double counting which leads to the overestimation of national income.
- Illegal Activities:
- Income earned through illegal activities like gambling, smuggling, illicit extraction of wine, etc. is not included in national income.
- Such activities have value and satisfy the wants of the people but they are not considered productive from the point of view of society.
Problems in Expenditure Method:
The following problems arise in the calculation of national income by expenditure method:
Government Services:
- In calculating national income by, expenditure method, the problem of estimating government services arises.
- Government provides a number of services, such as police and military services, administrative and legal services.
- In reality, it is not possible to make a clear demarcation as to which service protects the people and which protects the productive process.
- Therefore, all such services are regarded as final goods and are included in national income.
Transfer Payments:
- There arises the problem of including transfer payments in national income.
- Government makes payments in the form of pensions, unemployment allowance, subsidies, interest on national debt, etc.
- These are government expenditures but they are not included in national income because they are paid without adding anything to the production process during the current year.
- For instance, pensions and unemployment allowances are paid to individuals by the government without doing any productive work during the year.
- Subsidies tend to lower the market price of the commodities.
- Interest on national or public debt is also considered a transfer payment because it is paid by the government to individuals and firms on their past savings without any productive work.
Durable-use Consumers’ Goods:
- Durable-use consumers’ goods also pose a problem.
- Such durable-use consumers’ goods as scooters, cars, fans, TVs, furniture’s, etc. are bought in one year but they are used for a number of years.
- The expenditure on them is regarded as final consumption expenditure because it is not possible to measure their used up value for the subsequent years.
- But there is one exception. The expenditure on a new house is regarded as investment expenditure and not consumption expenditure.
- This is because the rental income or the imputed rent which the house-owner gets is for making investment on the new house.
- However, expenditure on a car by a household is consumption expenditure.
- But if he spends the amount for using it as a taxi, it is investment expenditure.
Public Expenditure:
- Government spends on police, military, administrative and legal services, parks, street lighting, irrigation, museums, education, public health, roads, canals, buildings, etc.
- The problem is to find out which expenditure is consumption expenditure and which investment expenditure is.
- Expenses on education, museums, public health, police, parks, street lighting, civil and judicial administration are consumption expenditure.
- Expenses on roads, canals, buildings, etc. are investment expenditure.
- But expenses on defence equipment are treated as consumption expenditure because they are consumed during a war as they are destroyed or become obsolete.
- However, all such expenses including the salaries of armed personnel are included in national income.
Way Forward-
Some suggestions to overcome the challenges in calculating national income accounting.
- Effective availability of statistical material.
- Eliminating dangers of double counting. The cost of the commodity is likely to be counted twice or thrice and national income will be overestimated.
- Inclusion of Non-marketed services: The unpaid services, or non-marketed services are excluded from the national income that should be included.
- Effective calculation of depreciation allowance:
- The deduction of depreciation allowances, accidental damages, repair, and replacement charges from the national income is not an easy task.
- It’ requires high degree of judgment to assess the depreciation allowance and other charges.
- Unreliable data:
- The statisticians themselves do not feel the importance of figures which they collect.
- They also do not take much pains for getting the reliable data.
- The figures of national Income are, therefore, not up-to-date in the under-developed countries.
Prelims of the day: –
1.Which of the following is/are methods to measure the National Income?
- Expenditure method
- Income method
- Output method
- All of the above
Answer: D
Explanation:
The national income of a country can be measured by three alternative methods: (i) Product Method (ii) Income Method, and (iii) Expenditure Method.
2.Which of the following represents the National Income?
- NNP at Market Cost
- NNP at Factor Cost
- NDP at Factor Cost
- NDP at Market Cost
Answer: A
Explanation:
- Net National Product (NNP) at market cost is equal to national income.
- Gross national product (GNP), total market value of the final goods and services produced by a nationals of the country during a specific period of time (usually a year)
- The Net National Product (NNP) of an economy is the GNP after deducting the loss due to ‘depreciation’.
- NNP = GNP – Depreciation.
3.Which of the following represents the GDP at constant prices?
- Nominal GDP
- Potential GDP
- Real GDP
- All the above
Answer: C
Explanation:
- GDP at constant price is the GDP adjusted for the effects of inflation.
- GDP at constant price is also referred to as real GDP
- Real gross domestic product (real GDP) is an inflation-adjusted measure that reflects the value of all goods and services produced by an economy in a given year
- It is also known as inflation-corrected GDP or constant price GDP
4.Which of the following represents the GDP at current prices?
- Nominal GDP
- Potential GDP
- Real GDP
- All the above
Answer: A
Explanation:
- GDP at current price is the GDP unadjusted for the effects of inflation and is at current market prices.
- GDP at current price is also referred to as nominal GDP.
5.Which of the following is the actual definition of transfer payments?
- Transfer payments refer to the payments made as compensation to the employees within an organisation
- Transfer payments refer to the payments made to workers on transferring from one job to another
- Transfer payments refer to the payments made without any exchange of goods and services
- None of the above
Answer: C
Explanation:
- A transfer payment is a monetary payment for which no goods or services are exchanged.
- The term “transfer payment” refers to government payments made to individuals through social programs such as welfare, student grants, and even Social Security.
- Government payments to corporations, however, are not commonly referred to as transfer payments.
6.Which of the following is not a part of the National Income?
- Undistributed profits
- Income from government expenditure
- The interest amount on the unproductive national debt
- The payments made by a household to a firm for purchasing goods and services
Answer: C
Explanation:
- The total value of final goods and services produced by the normal residents during an accounting year, after adjusting depreciation.
- It is Net National Product (NNP) at Factor Cost (FC)
- It does not include taxes, depreciation and non-factor inputs (raw materials)
- Items which are not included in National Income: Intermediate goods, Sale and purchase of old goods and existing services (shares are not included unless they are through an IPO), Windfall gains (lottery income), Black money (cannot be estimated), Work done by housewives, the interest amount on the unproductive national debt etc.
7.Which of the following is correct for Disposable Income?
- Disposable Income is the difference between Private Income and Indirect Taxes
- Disposable Income is the difference between Personal Income and Indirect Taxes
- Disposable Income is the difference between Private Income and Direct Taxes
- Disposable Income is the difference between Personal Income and Direct Taxes
Answer: D
Explanation:
- The Disposable Income=Personal Income – Direct Taxes.
- But the whole of disposable income is not spent on consumption and a part of it is saved.
- Therefore, disposable income is divided into consumption expenditure and savings.
- Thus Disposable Income = Consumption Expenditure + Savings.
8.Which of the following organization is calculating the Gross Domestic Product in India?
- Reserve Bank of India
- Indian Statistical Institute
- National Statistical Office
- None of the above
Answer: C
Explanation:
The National Statistics Office:
The National Statistics Office (CSO), under the Ministry of Statistics and Program Implementation, is responsible for calculating the GDP of India, macroeconomic data gathering, and statistical record keeping
9.Which of the following is true for inflation?
- The value of money increases during Inflation
- The value of money decreases during Inflation
- The value of money stays the same during Inflation
- None of the above
Answer: B
Explanation:
- In economics, inflation (or less frequently, price inflation) is a general rise in the price level of an economy over a period of time.
- When the general price level rises, each unit of currency buys fewer goods and services,
- Consequently, inflation reflects a reduction in the purchasing power per unit of money – a loss of real value in the medium of exchange and unit of account within the economy.
10.What is the consumption of Fixed Capital means?
- Depreciation
- Capital Formation
- Investment
- All of the above
Answer: A
Explanation:
- Depreciation is also called consumption of fixed capital.
- Depreciation means loss of fixed assets overtime due to wear and tear.