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The total value of all the goods and services produced in a country in a given year is represented by national income. The term ‘income’ is the total of incoming wages, money received on interests, dividends, and other investments. The income of a country is the national income. The national income represents the net result of any country’s economic activities. Now, the national income can be calculated in three ways: value-added, income, and expenditure methods.
Calculating National Income
The goods and services produced in an economy require four factors of production: land, labour, capital, and entrepreneurship.
The land here means land in the form of a place where we can set up factories or offices and encompass all the natural resources and raw materials. It includes renewable and non-renewable resources such as water, oil, metal, etc. The business owner has to pay rent to the landowner to use the land.
Labour is the work done by human resources to produce goods and services. All the people employed in factories and offices come under this category since they help produce something of economic value. In return for their service, labourers are paid wages.
Capital includes all the tools and machinery which are required for production. Interest is earned on capital.
The last factor of production is entrepreneurship. An entrepreneur is someone who earns a profit for manufacturing a good or providing a service by combining the other three factors of production.
In summary, rent is earned on land, wages are paid for labour work, interest is earned on capital, and profit is made by entrepreneurship. The ones who own these factors of production get paid. They then spend this money to purchase goods and services produced in the economy. Hence, a cycle is formed.
Production of goods and services creates income, which people use for expenses, and further production is done through expenditure. This flow is called the circular flow of national income. There are three ways to calculate national income:
Value Added Method
Income Method
Expenditure Method
Value Added Method
In this method, the cost of the product is estimated at the production level at different stages.
Let’s take one national income example of the production of bread.
Flour is needed to produce bread. Suppose the baker buys flour for Rs 20 from a farmer.
Then, the baker uses his skill to make bread from flour. He sells this in the market for Rs 40.
Rs 20 have been added by the baker to the value of the bread.
Hence, it is known as the value-added method. This is one of the best methods as it solves the problem of double counting.
To calculate the net value added at factor cost, the total value of intermediate goods (IG), net indirect taxes (NIT), and depreciation (D) need to be subtracted from the gross value of output.
Mathematically, net value added at factor cost = Gross value of output – (IG + NIT + D)
In this method, we do not include the value of self-consumption services. For example, the work done by a housewife (which is a form of service) adds no economic value. The value of self-consumption goods, however, should be calculated.
Income Method
In this method, incomes of the various factors of production are added together in a given year.
Let’s understand this by an example. Given data is in crores:
wages and salaries (400),
rent (500),
interest (100), and
undistributed profit (50).
Net domestic product at factor cost = 400 + 500 + 100 + 50 = 1050 crores
If we have to calculate net national product at factor cost, we have to add the net income from abroad.
Expenditure Method
The last calculation method is done by adding up the final expenditure on products and services in an economy in a given period. GDP at market price can be calculated by adding final expenditure by government and private bodies, gross investment, and net exports. Depreciation and net indirect taxes are deducted from this to get the value of NDP at factor cost.
Conclusion
National income is calculated using the value of the net national product at factor cost. If we have the value of GDP at market price, then NNP at factor cost can be calculated by adding subsidies and net income from abroad and subtracting indirect taxes and consumption of fixed capital. It is crucial to note that all three methods to calculate national income – value-added, income, and expenditure method- should lead to the same answer.
