Measurements of National Income: Methods and Economic Performance

National income refers to the total value of all goods and services produced within a country’s borders in a specific time frame, typically a year. It’s a key indicator of a country’s economic performance and is used to measure the overall economic activity and standard of living within that nation.

National income can be calculated using various methods, such as the production or value-added method, income method, or expenditure method, 

Aggregate Income Measurement: Expenditure, Product, and National Income Methods

Aggregate income can be measured through three methods: expenditure method, product method, and income method. Refer Figure to understand the GDP by three methods.

GDP by three Methods

• The Expenditure Method: It calculates aggregate income by measuring the spending firms receive for final goods and services produced.
• The Product Method: It measures aggregate income by calculating the aggregate value of final goods and services produced by all firms.
• The Income Method: It calculates aggregate income by summing up all factor payments (wages, interest, profit, rent).

Simplified Economic Models: Essential Features and Adaptation

• Macroeconomic Model Representation: The described model is a simplified representation of an economy and serves as a macroeconomic model.
• Aim of Model: It  focusses to highlight essential features of economic systems, but they do not capture every detail.
• Adaptive Model Selection: Economists use various models to analyze different real-life situations, selecting the most appropriate one for a given context.

The Impact of Savings: Consistency in Aggregate Income Estimation

• The introduction of savings into the simple model does not fundamentally change the conclusion that the aggregate estimate of national income remains the same.
• The annual production of goods and services, estimated through the three methods, remains consistent even in more complex economies.

The Product or Value Added Method: Calculating Economy’s Value Added with Examples

• The product method is used to calculate the aggregate annual value of goods and services produced in an economy.
• It involves summing up the value added by all the firms in the economy.
• Example: The example involves two types of producers – wheat producers (farmers) and bread makers (bakers).
  •  In a year, farmers produce wheat with a total value of Rs 100, out of which they sell Rs 50 worth of wheat to bakers. 
  • The bakers use this wheat to produce bread with a value of Rs 200.

Value Added: Assessing a Firm’s Net Contribution in Production

• Meaning: The term that is used to denote the net contribution made by a firm is called its value added.
  • Value added by a firm is calculated as the value of production minus the value of intermediate goods used (Refer Table).
• Example:
  • For the farmers, their value added is Rs 100 (the entire value of their wheat production). 
  • For the bakers, their value added is Rs 200 (bread production) minus Rs 50 (the value of wheat they bought from the farmers), which equals Rs 150.

Production, Immediate Goods and Value Added

Gross and Net Value Added: Understanding Economic Contributions

• Gross Value Added: It  includes depreciation in value added then the measure of value added that we obtain is called Gross Value Added.
  • Deducting the value of depreciation from gross value added to get Net Value Added. 
• Net Value Added: It does not include wear and tear that capital has undergone Like Gross value added.
• Example: Assume a firm produces Rs 100 worth of goods per year, Rs 20 is the value of intermediate goods used by it during the year and Rs 10 is the value of capital consumption.
  • The gross value added of the firm will be Rs 100 – Rs 20 = Rs 80 per year.
  • The net value added will be, Rs 100 – Rs 20 – Rs 10 = Rs 70 per year.

Inventory: Impact on Capital and Investment

• Definition: In economics, It refers to the stock of unsold finished or raw goods a firm holds from one year to the next, with changes indicating accumulation (increase) or decumulation (decrease) in value over time.
  • It’s a crucial variable for assessing a company’s production and sales dynamics.
• The change of inventories of a firm during a year ≡ production of the firm during the year – sale of the firm during the year. (≡ means identity. Unlike equality (‘=’), an identity always holds irrespective of what variables we have on the left-hand and right-hand sides of it.)
• Example: Let us suppose that a firm had an unsold stock worth Rs 100 at the beginning of a year. 
  • During the year it had produced Rs 1,000 worth of goods
  • It managed to sell Rs 800 worth of goods. 
  • Therefore, Rs 200 is the difference between production and sales. 
  • This Rs 200 worth of goods is the change in inventories. 
  • This will add to the Rs 100 worth of inventories the firm started with.
  • Hence the inventories at the end of the year is, Rs 100 + Rs 200 = Rs 300. 
• Flow Variable: Notice that change in inventories takes place over a period of time. 
  • Therefore it is a flow variable.
• Capital and Investment: Inventories are treated as capital and addition to the stock of capital of a firm is known as investment. 
  • Therefore, a change in the inventory of a firm is treated as an investment.
• Three major categories of investment are as follows:
  • Inventory Investment: This involves the increase in the value of a firm’s inventories over a year, considered as an investment expenditure made by the firm.
  • Fixed Business Investment: It comprises investments in machinery, factory buildings, and equipment by firms to enhance their production capabilities.
  • Residential Investment: This category relates to investments made in housing facilities, such as construction and improvement of residential properties.
• Change in inventories can be planned or unplanned,
  • Unplanned Accumulation of Inventories: It occurs when sales fall unexpectedly, resulting in unsold goods beyond expectations. Conversely, 
  • Unplanned Decumulation of Inventories: It happens when there’s an unexpected increase in sales, reducing inventories more than anticipated.
• Example – Suppose a firm produces shirts. It starts the year with an inventory of 100 shirts. During the coming year, it expects to sell 1,000 shirts. 
  • Hence, it produces 1,000 shirts, expecting to keep an inventory of 100 at the end of the year.
  • Unplanned Accumulation: However, during the year, the sales of shirts turned out to be unexpectedly low.
    • The firm is able to sell only 600 shirts.
    • This means that the firm is left with 400 unsold shirts. 
    • The firm ends the year with 400 + 100 = 500 shirts. 
    • The unexpected rise of inventories by 400 will be an example of the unplanned accumulation of inventories.
  • Unexpected Decumulation: If, on the other hand, the sales had been more than 1,000 we would have unplanned decumulation of inventories. For example,
    • If the sales had been 1,050, then not only the production of 1,000 shirts would be sold, but the firm would have to sell 50 shirts out of the inventory. 
    • This 50 unexpected reduction in inventories is an example of unexpected decumulation of inventories.

Calculating GDP: Expenditure Method and Final Expenditures

• An alternative approach to calculating GDP is through the expenditure method, which focuses on the demand side of products. 
• Example:

• • The Rs 50 worth of wheat that the bakers buy from the farmers counts as intermediate goods, hence it does not fall under the category of final expenditure. 
  • Therefore the aggregate value of output of the economy is Rs 200 (final expenditure received by the baker) + Rs 50 (final expenditure received by the farmer) = Rs 250 per year.
• Baked on the  example of the farmer-baker described earlier, the aggregate value of the output in the economy using the expenditure method is determined as follows: 
  • Calculate the final expenditures made by each firm. 
  • Final expenditure refers to spending, not for intermediate purposes.
  • Sum up the revenues earned by each firm from final consumption (C), investment (I), government spending (G), and exports (X). 
  • This is represented as RVi for each firm.
  • (C): Calculate the aggregate final consumption expenditure (C), which includes spending on domestic firms but excludes spending on imported consumption goods (Cm) for the entire economy.
  • (I): Calculate the aggregate final investment expenditure (I), which includes spending on domestic firms but excludes spending on foreign investment goods (Im).
  • (G): Determine the aggregate final government expenditure (G) for the economy, which includes spending on domestic firms but excludes spending on imports (Gm).
  • (X): Calculate the aggregate exports (X) received by the economy from foreign buyers.
  • (M): Subtract the aggregate imports expenditure (M), which includes spending on imports of consumption goods (Cm), imports of investment goods (Im), and government spending on imports (Gm).
  • Express GDP using the expenditure method as GDP = C + I + G + X – M.

• This equation provides a way to calculate GDP based on final expenditures on consumption, investment, government spending, exports, and imports
• It is worth noting that investment expenditure (I) is often the most variable component in this calculation.

Income Method: Calculating GDP Through Factor Incomes

• The income method of calculating GDP focuses on the national income received by all the factors of production, such as labor, capital, entrepreneurship, and land. 
• It establishes a relationship between the sum of final expenditures in the economy and the national income earned by households and factors of production.

Here’s how the national income method is applied:

• Consider there are M households in the economy, and let,
  • Wi represent the wages and salaries received by the i-th household,
  • Pi for gross profits, 
  • Ini for interest payments, and
  • Ri for rents in a specific year.
• GDP is calculated as the sum of these various national income components:
  •  GDP = Σ(Wi) + Σ(Pi) + Σ(Ini) + Σ(Ri). (The symbol Σ is a notation – it is used to denote summation.)
• The total national income earned by all households is expressed as GDP.
• This method essentially states that the revenues earned by all firms in the economy should be distributed among the factors of production such as salaries, wages, profits, interest earnings, and rents.
• When considering the national income method along with the value-added method and expenditure method, they all provide different expressions of the same GDP variable.
• These methods represent the relationship between production, expenditure, and national income.

National Income Measurement in India: Factor Cost, Basic Prices, and Market Prices

• The Central Statistics Office (CSO) of the Government of India has been reporting the GDP at factor cost and at market prices. 
• GVA at Basic Prices: In January 2015 the CSO replaced GDP at factor cost with the GVA at basic prices, and the GDP at market prices, which is now called only GDP, is now the most highlighted measure.
• The Measurement of National Income in India: It involves various concepts such as GDP at factor cost, GDP at market prices, GVA at basic prices, and the distinction between production taxes and product taxes, as well as subsidies.

• GVA at Basic Prices as a key Measure: In recent years, the Central Statistics Office (CSO) of the Government of India has shifted its focus from GDP at factor cost to GVA at basic prices as a key measure of national income (Refer Table). 
  • This change highlights the importance of understanding the distinction between various taxes and subsidies related to production and products in calculating national income.
• 

GVA and GDP for India at constant (2011-2012) price

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