METHODS OF NATIONAL INCOME

National income refers to the total value of all goods and services produced in a
country over a specific period, typically measured annually or quarterly. It is a
crucial indicator of the economic performance of a country. There are three
primary methods used to calculate national income:
1. Production Method
2. Income Method
3. Expenditure Method

Here’s a detailed explanation of each:

1. Production Method (or Output Method)

The production method calculates national income by determining the value
added at each stage of production within the economy. The Production Method
(also called the Value Added Method) calculates national income by summing the
value added at each stage of production of all goods and services in the economy.
It’s the most direct method to measure the total output in an economy. It involves
summing up the outputs produced by different sectors of the economy, such as
agriculture, industry, and services. The key idea here is to calculate the total output
and subtract the value of intermediate goods to avoid double counting.
Steps in the Production Method
1. Identify the Sectors of the Economy:
o The economy is typically divided into three main sectors:
▪ Primary Sector: Agriculture, mining, fishing, etc.
▪ Secondary Sector: Manufacturing, construction, etc.
▪ Tertiary Sector: Services such as banking, insurance,
transportation, healthcare, education, etc.
2. Calculate the Value Added in Each Sector:
o For each sector, calculate the value added by subtracting the cost of
intermediate goods from the value of output produced.
o The value added is the contribution made by each sector to the
overall economy.
3. Add the Value Added:
o The final national income is the sum of the value added in all sectors.
Formula for the Production Method
The formula for calculating national income using the Production (or Output)
Method is:
National Income (NI)=∑(Value Added in Each Sector)
Where:
• Value Added is the difference between the value of output and the cost of
intermediate goods.
• This value is calculated for each sector (primary, secondary, and tertiary) and
then summed up.
Example of the Production Method
 Let's walk through a simplified example to understand how this method
works:
1. Agricultural Sector (Primary Sector)
• A farmer grows wheat and sells it to a miller for Rs 500.
• The farmer's value added is simply the sale price of the wheat: Rs 500.
2. Manufacturing Sector (Secondary Sector)
• The miller buys the wheat for $500 and processes it into flour, which he sells
to a bakery for Rs 700.
• The miller’s value added is the difference between the selling price and the
cost of wheat:
Value Added by Miller=700−500=200
3. Service Sector (Tertiary Sector)
• The bakery sells the flour-based product (bread) to customers for Rs 1,000.
• The bakery’s value added is the difference between the sale price of the
bread and the cost of flour:
Value Added by Bakery=1,000−700=300
4. Total Value Added
Now, we sum up the value added by each sector:
Total National Income=500 (Agriculture)+200 (Manufacturing)+300 (Services)=1,
000
In this example, the national income of the country, using the Production Method,
would be Rs1,000.
Advantages of the Production Method
1. Avoids Double Counting:
o By focusing on value added, this method avoids the problem of
double counting that can occur if we try to sum the value of all goods
and services produced in the economy, including intermediate goods.
 2. Direct Measure of Output:
o It gives a direct picture of the actual production in the economy,
making it easier to understand how much the country is producing in
different sectors.
3. Clear Breakdown by Sector:
o The method allows for a clear understanding of how much each sector
(agriculture, manufacturing, services, etc.) contributes to the overall
economy.
Limitations of the Production Method
1. Difficulties in Estimation:
o In some cases, accurately estimating the value added in informal
sectors (like small businesses, self-employment) or certain services
can be difficult.
2. Data Availability:
o To apply this method, reliable data on the output and costs of
production for different sectors are needed. In some countries,
comprehensive data may not be available.
3. Exclusion of Non-Market Activities:
o The production method may not fully capture non-market activities,
such as household labor, which contributes to the economy but is not
included in the market transactions.
4. Valuation of Services:
o The valuation of services (like healthcare or education) can be
difficult because these are often non-traded services or may be
provided by the government at subsidized rates
2. Income Method :- The Income Method of calculating national income is one of
the three primary approaches used to measure a country's total economic output,
the other two being the Production Method and the Expenditure Method.
The income method calculates national income by summing up all the incomes
earned in the production of goods and services. These incomes include wages,
rents, interests, and profits earned by individuals and businesses in the economy.
The primary focus here is on the payments made to the factors of production: land,
labor, capital, and entrepreneurship.
In the income method, national income is calculated by summing up all the
incomes earned by individuals and businesses in the production of goods and
services within a country. This includes:
1. Wages and Salaries: Payments made to employees for their labor.
2. Rent: Income earned by owners of land or property.
3. Interest: Income earned by individuals or institutions who lend capital.
4. Profits: Earnings of businesses after expenses are deducted.
5. Mixed Incomes: Earnings of self-employed individuals (who often combine
labor and capital in their work).
6. Taxes less subsidies on production and imports: Adjustments to account for
taxes or subsidies that affect income generation.

The formula for calculating national income using the income method is:
National Income (Y) = Wages + Rent + Interest + Profits + Mixed Incomes +
(Indirect Taxes – Subsidies)
This method focuses on the income generated through the production process,
which is distributed among the factors of production (land, labor, capital, and
entrepreneurship).
Example 1.
Given the following data and using income method calculate:
(a) Net Domestic Income, (b) Gross Domestic Income, (c) Net National Income,
and (d) Net National Product at Market Price.
Items (in crore)
(i) Indirect taxes 9,000
(ii) Subsidies 1,800
(iii) Depreciation 1,700
(iv) Mixed income of self-employed 28,000
(v) Operating surplus 10,000
(vi) Net factor income from abroad (-) 300
(vii) Compensation of employees 24,000
Solution:
(a) Net Domestic Income

- Mixed income of self-employed + + Compensation of employees Operating

surplus = 28,000 crore + ₹10,000 crore + ₹ 24,000 crore = 62,000 crore
Net domestic income = 62,000 crore.
(b) Gross Domestic Income
= Net domestic income + Depreciation
62,000 crore + 1,700 crore
= 63,700 crore
Ans. Gross domestic income = 63,700 crore.
(c) Net National Income
= Net domestic income + Net factor income from abroad = 62,000 crore + (-) 300
crore =62,000 crore - 300 crore
61,700 crore
Ans. Net national income = 61,700 crore.
(d) Net National Product at Market Price
Net national income + Indirect taxes - Subsidies
₹61,700 crore +9,000 crore - 1,800 crore
68,900 crore
Ans. Net national product at market price = 68,900 crore.

3. The Expenditure Method

This method calculates national income by summing up all the expenditures made
in an economy during a given period. The expenditures include both consumption
and investment. The major components of expenditure are:
Consumption Expenditure (C)
• This is the total spending by households on final goods and services. It
includes durable goods (e.g., cars, appliances), non-durable goods (e.g.,
food, clothing), and services (e.g., healthcare, education).
• Consumption is typically the largest component of national income in most
economies.
Investment Expenditure (I)
• Investment expenditure refers to spending by businesses on capital goods,
such as machinery, equipment, factories, and infrastructure. It also includes
residential construction and changes in inventories.
• There are two main types of investment:
 o Private Investment: Spending by businesses on capital goods and
services.
o Public Investment: Government spending on infrastructure, like
roads, bridges, and schools.
• Investment is crucial because it determines the future productive capacity of
the economy.
Government Spending (G)
• This is the total expenditure by the government on goods and services for
public use, such as defense, education, healthcare, transportation, and public
administration.
• Government spending can also include transfer payments like
unemployment benefits and pensions, though these are usually excluded
from the national income calculation (since they are not payments for goods
or services).
Net Exports (NX)
• Net exports are the difference between a country’s exports and imports:
o Exports (X): Goods and services sold to other countries.
o Imports (M): Goods and services purchased from other countries.
• Net exports are calculated as NX=Exports−Imports. A positive value
indicates a trade surplus (exports > imports), while a negative value
indicates a trade deficit (imports > exports)
The formula for national income using the expenditure method is:
National Income (Expenditure Method)=C+I+G+(X−M)
Where:
• C = Consumption expenditure
• I = Investment expenditure
• G = Government expenditure
• (X−M)= Net exports (Exports - Imports)