Approaches to Measuring National Income

The compilation of national income statistics is a very laborious task.  The total wealth of a nation has to be added up and there are millions of nationals.  Moreover, in order to double check and triple check the statistics, the national income statistician has to work out the figures out in three different ways, each way being based on a different aspect.  The three aspects are:

  • The National Output: The creation of wealth by the nation’s industries. This is valued at factor cost, so it must be the same as b) below.
  • The National Income: The incomes of all the citizens
  • The National Expenditure: because whatever we receive we spend, or lend to the banks to invest it, so that the addition of all the expenditure should come to the same as the other two figures. Put in its simplest form we can express this as an identity

1) The output/product/value added/net output method of measuring national income

In this method value of output of all the firms in the economy is added together to arrive at national income figure. To aid in this the economy is divided into different productive sectors eg farming, fishing, mining etc.  It is a useful method where a census of production of the economy is required. It is important that only the value added at each stage of production or by each firm is counted in order to avoid double counting. The term value added of the firm may be defined as the difference between the total value at each stage and the value of the previous stage. For example:  Consider a case of wheat bread production shown below:

Farmer 100,000 100,000
Miller 150,000 50,000
Bakers 180,000 30,000
Retailers large/wholesalers 190,000 10,000
Retailers 200,000 10,000
Total 820,000 200,000

To avoid double counting we use value added only or the other approach is to add the final product only. Imports if and only if included in the total output should be excluded and exports if excluded should be included.

The figure obtained is further adjusted by adding net factor income from abroad. This is the most direct method of calculating national income.

Adjustments to be made

  • Stock appreciation – subtracted.
  • Residual errors – subtracted.
  • Net factor income from abroad – added if positive and subtracted if negative.
  • Depreciation

2) The Income Method of Measuring National Income

Income method approach is from the distribution side. In this approach national income is got by adding together all the rewards earned by all factors of production for a given period. We include only those particular income flows that originate with the production of goods and services whose total we seek to estimate.

Only then will the total income flows equal the total of the goods and services. In an economy income is earned as follows

  • Land receives rent (R)
  • Labour receives wages (w)
  • Capital receives interest (r)
  • Enterprenuer receives profit (π)

So that Y = R + W + r + π, however the following also should be taken into account:

  • Retained earnings – (re) that part of profit retained by firms should be taken into account
  • Subsistence income (sy) – this occurs in a case where income is not paid but services are rendered eg services of housewives, self-provided services etc.

The following should be excluded:

  • Transferred payment (tp) – Payment made without satisfying ‘Quid Pro Quo’ criteria ie income for which the recipient provides no good or service.
  • We should exclude income received from people who sell building, automobiles or things produced in a previous period, because what they receive in payment is ‘not income’ in the sense of something generated in the cause of producing the output of the current period (py)
  • Anything for which neither a good or a service is supplied in exchange and for which there is therefore no corresponding for example receipts of people who sell bonds and debentures (S)

Therefore National Income will be expressed as follows:

Y = R + W + r + Re + π + Sy – tp – Py – S

Y = C + S + T + Rpf

3) The Expenditure Method of Measuring National Income

In this approach we add together all types of spending on finished goods and services in an economy.  It involves counting each unit produced at the time of purchase and valuing it at the actual purchase price.  If we add up total expenditure on goods and services, we will have (subject to a number of qualifications).  The total we seek and also a total in which each unit of output is valued at what appears to be the best available indicator of the value of that unit to the society i.e. the price actually paid for it.

Different types of spending in an economy are identified and added together:

  • Personal consumption expenditure (C) Spending in food items, services, durable goods by households.
  • Private domestic investment (Gross) (I): This includes all purchases of machinery, tools and equipment, all construction whether residential as commercial and changes in inventory.

Inventory changes as investments are produced and not sold or sold when not produced in the present period.  If at the end of the year firms have more stock on the shelves than at the end of the year it means that the economy has produced more than it has consumed. Therefore positive changes should be added when GNP is determined. For inventory decline we subtract from GNP since GNP is a measure of the current year’s output and we must omit anything produced in past or previous years. A fall in inventory means that the economy consumed more than it produced in a given year, thus consuming previous year’s production.

  • The Government (G) All government spending on final goods and services should be included but exclude spending on transferred payments as well as subsidies.
  • Exports and Imports Spending by foreigners on goods and services produced in a country should be included. Export is symbolized by (X), Imports is spending on foreign goods and services produced in other countries. It is symbolized by (M).

Net export (Xn) is the amount by which foreign spending on our goods and services exceed the amount of spending on goods and services exceed the amount of spending on goods and services produced by foreigners.

Therefore, GNP = C + I + G + X – M; also measures aggregate demand of an economy.

Exclusions from Expenditure

The desired total measures the amount of output produced by an economy in a specified period of time. Thus it must clearly indicate only expenditures on the purchase of goods and services produced in that period. The exclusions include:

  • Any part of billions of shillings spent during that period on goods produced in earlier periods. All expenditures of this kind merely reflect changes in the ownership of pre-existing output.  As such they are not part of the total of expenditure that measures the values of total output.
  • It must exclude all expenditures of things that are neither goods nor services and therefore do not reflect production at all either current or past. For example spending on stocks and bonds. There is no production or output of goods and services corresponding to expenditure on mere pieces of paper.
  • All expenditure by central and local government for which the government does not receive a good or services in exchange e.g. transfer of payments.
  • Spending on intermediate products so as to avoid double counting

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