CBSE Class 12 Macroeconomics National Income And Related Aggregates Notes Set 03

METHODS OF CALCULATING NATIONAL INCOME

• Methods of Calculating National Income
• Value Added Method (with reference to the Problem of Double Counting)
• Income Method (with reference to the Concept of Operating Surplus)
• Expenditure Method (with reference to the Classification of Final Expenditure as Consumption Expenditure and Investment Expenditure)

1. METHODS OF CALCULATING NATIONAL INCOME

Circular Flow Model (chapter 2) reveals that national income can be viewed from three different angles:
(i) as the sum total of value addition in the economy,
(ii) as the sum total of income generated in the economy, and
(iii) as the sum total of expenditure on the final goods and services produced in the economy.
Corresponding to the three different way of looking at national income, the economists have suggested three methods of calculating national income. These are:
(i) Value Added Method, (ii) Income Method, and (iii) Expenditure Method. Following is a brief description of these methods.

2. VALUE ADDED METHOD (OR PRODUCT METHOD)

Value Added Method measures national income in terms of value addition by each producing enterprise in the economy during an accounting year. This is also known as Industrial Origin Method or Net Output Method. Estimation of the contribution of all producing enterprises to production in the domestic territory of the country during the year is equal to the market value of GDP, called \( \text{GDP}_{\text{MP}} \). It is adjusted to find out \( \text{NNP}_{\text{FC}} \) or national income.

Value Added

Value added is the difference between value of output of an enterprise and the value of its intermediate consumption.
Value Added = Value of output – Intermediate consumption

Value of Output

It refers to market value of the goods (or services) produced by a firm during an accounting year. If the entire output of the year is sold during the year, value of output = sales.
Value of Output = Sales, if entire output of the year is sold during the year
If some output remains unsold, it is added to the firm's inventory stock. It is expressed as change in stock (\( \Delta \text{stock} \)) during the year. In such a situation, value of output is measured as the sum total of 'sales during the year' and 'change in stock during the year'.
Value of Output = Sales + \( \Delta \text{Stock} \), if some output remains unsold during the year

Change in Stock (\( \Delta \text{Stock} \))

It is measured as the difference between 'closing stock of the accounting year' and 'opening stock of the accounting year'.
\( \Delta \text{Stock} = \text{Closing Stock} - \text{Opening Stock} \)

Intermediate Consumption

It refers to value of non-factor inputs (all inputs other than factor inputs of land, labour, capital and entrepreneurship). Primarily, it includes value of raw material used in the process of production.

Illustration

Table 1 illustrates how 'value added' is estimated.

Table 1. Estimating Value Added (or Value Addition)

In Table 1, it is assumed that the production of wheat involves cost of intermediate consumption of Rs. 200 (it may include cost of inputs like seeds, fertilizers, irrigation expenses, etc.). Accordingly, value added by the farmer is equal to Rs. 600 - Rs. 200 = Rs. 400.

• The flour mill buys wheat for Rs. 600 and sells flour for Rs. 800. Value added by the flour mill, therefore, is equal to Rs. 800 - Rs. 600 = Rs. 200.
• Further, the baker buys flour for Rs. 800 and sells the bread for Rs. 1,000 to the shopkeeper. The value added by the baker is Rs. 1,000 - Rs. 800 = Rs. 200.
• The shopkeeper buys the bread for Rs. 1,000 and sells the bread to the households for Rs. 1,200. The value added by the shopkeeper is Rs. 1,200 - Rs. 1,000 = Rs. 200.

Thus, the gross value added by all the producing enterprises is Rs. 400 + Rs. 200 + Rs. 200 + Rs. 200 = Rs. 1,000.
Gross value added by all the producing enterprises within the domestic territory of a country during an accounting year is called \( \text{GDP}_{\text{MP}} \) (gross domestic product at market price).

\( \text{GDP}_{\text{MP}} \) = Gross Value Added by all producing enterprises within the domestic territory of a country during the period of one year.
= Market value of final goods and services produced in the economy during the period of one year.

Having estimated \( \text{GDP}_{\text{MP}} \), we find out \( \text{NNP}_{\text{FC}} \) (national income) in terms of the following equation:
\( \text{GDP}_{\text{MP}} \)
- Depreciation
= \( \text{NDP}_{\text{MP}} \)
- Net indirect taxes
= \( \text{NDP}_{\text{FC}} \)
+ Net factor income from abroad
= \( \text{NNP}_{\text{FC}} \) (National Income)
[As noted earlier, national income is often identified with \( \text{NNP}_{\text{FC}} \).]