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There are three methods or approaches of measuring or computing national income of a country. They yield the same result. These methods or approaches are:

(1) The Product Method.

(2) The Income Method.

(3) The Expenditure Method.

We now look at each of the three methods in turn.

(1) Product Method or Value Added Method:

Definition:

Goods and services are counted in gross domestic product (GDP) at their market values. The product approach defines a nation’s gross product as that market value of goods and services currently produced within a nation during one year period of time.

The product approach measuring national income involves adding up the value of all the final goods and services produced in the country during the year. Here we focus on various sectors of the economy and add up all their production during the year. The main sectors whose production value are added up:

(i) Agriculture (ii) manufacturing (iii) construction (iv) transport and communication (v) banking (vi) administration and defense and (vii) distribution of income.

Precautions:

There are certain precautions which are to be taken to avoid miscalculation of national income using this method. These in brief are:

(i) Problem of double counting: When we add up the value of output of various sectors, we should be careful to avoid double counting. This pitfall can be avoided by either counting the final value of the output or by including the extra value that each firm adds to an item.

(ii) Value addition in particular year: While calculating national income, the values of goods added in the particular year in question are added up. The values which had previously been added to the stocks of raw material and goods have to be ignored. GDP thus includes only those goods, and services that are newly produced within the current period.

(iii) Stock appreciation: Stock appreciation, if any, must be deducted from value added. This is necessary as there is no real increase in output.

(iv) Production for self consumption: The production of goods for self consumption should be counted while measuring national income. In this method, the production of goods for self consumption should be valued at the prevailing market prices.

(2) Income Method:

Definition:

Income method or approach is another alternative way of computing national income. This method seeks to measure national income at the phase of distribution. In the production process of an economy, the factors of production are engaged by the enterprises. They are paid money incomes for their participation in the production. The payments received by the factors and paid by the enterprises are wages, rent, interest and profit.

National income thus may be defined as the sum of wages, rent, interest and profit received or occurred to the factors of production in lieu of their services in the production of goods. Briefly, national income is the sum of all income, wages, rents, interest and profit paid to the four factors of production.

The four categories of payments are briefly described below:

(i) Wages: It is the largest component of national income. It consists of wages and salaries along with fringe benefits and unemployment insurance.

(ii) Rents: Rents are the income from properly received by households.

(iii) Interest: Interest is the income private businesses pay to households who have lent the business money.

(iv) Profits: Profits are normally divided into two categories (a) profits of incorporated businesses and (b) profits of unincorporated businesses (sold proprietorship, partnerships and producers cooperatives).

Precautions:

While estimating national income through income method, the following precautions should be undertaken.

(i) Transfer payments such as gifts, donations, scholarships, indirect taxes should not be included in the estimation of national income.

(ii) Illegal money earned through smuggling and gambling should not be included.

(iii) Windfall gains such as prizes won, lotteries etc., is not be included in the estimation of national income.

(iv) Receipts from the sale of financial assets such as shares, bonds should not be included in measuring national income as they are not related to generation of income in the current year production of goods.

(3) Expenditure Method:

Definition:

The expenditure method or approach measures national income as total spending on final goods and services produced within nation during an year. The expenditure approach to measuring national income is to add up all expenditures made for final goods and services at current market prices by households, firms and government during a year.

Formula:

Total aggregate final expenditure on final output thus is the sum of four broad categories of expenditures:

(i) Consumption (ii) investment (iii) government and (iv) net export.

(i) Consumption expenditure (C): Consumption expenditure is the largest component of national income. It includes expenditure on all goods and services produced and sold to the final consumer during the year.

(ii) Investment expenditure (I): Investment is the use of today’s resources to expand tomorrow’s production or consumption. Investment expenditure is expenditure incurred on by business firms on (a) new plants, (b) adding to the stock of inventories and (c) on newly constructed houses.

(iii) Government expenditure (G): It is the second largest component of national income. It includes all government expenditure on currently produced goods and services but excludes transfer payments while computing national income.

(iv) Net exports (X – M): Net exports are defined as total exports minus total imports.

National income calculated from the expenditure side is the sum of final consumption expenditure, expenditure by business on plants, government spending and net exports.

NI = C + I +G + (X – M) Precautions

Precautions:

While estimating national income through expenditure method, the following precautions should be taken:

(i) The expenditure on second hand goods should not be included as they do not contribute to the current year’s production of goods.

(ii) Similarly, expenditure on purchase of old shares and bonds is not included as these also do not represent expenditure on currently produced goods and services.

(iii) Expenditure on transfer payments by government such as unemployment benefit, old age pensions, interest on public debt should also not be included because no productive service is rendered in exchange by recipients of these payments.

Why Three Methods of Computing or Measuring National Income are Equal?

The three approaches used for measuring national income give the same result.

The reason is the market value of goods and services produced in a given period by definition is equal to the amount that buyers must spend to purchase them. So the product approach which measures market value of good and services produced and the expenditure approach which measures spending should give the same measure of economic activity.

Now as regards the income approach or method, the sellers receipts must equal what the buyers spend. The sellers receipts in turn equal the total income generated by the economic activity. Thus, total expenditure must equal total income generated implying that the expenditure and income approach must also produce the same result.