ICSI Notes: National Income Accounting | Economics for CSEET PDF Download

 Page 1


449
Economic and  
Business Environment
NATIONAL INCOME ACCOUNTING 
AND RELATED CONCEPTS
LESSON 2
Page 2


449
Economic and  
Business Environment
NATIONAL INCOME ACCOUNTING 
AND RELATED CONCEPTS
LESSON 2
450
CSEET Reference Reading Material - I
Economic and  
Business Environment
INTRODUCTION
National income is an uncertain term which is used interchangeably with national dividend, national 
output and national expenditure. On this basis, national income has been defined in a number of 
ways. In common parlance, national income means the total value of goods and services produced 
annually in a country.
In other words, the total amount of income accruing to a country from economic activities in a year’s 
time is known as national income. It includes payments made to all resources in the form of wages, 
interest, rent and profits.
National Income or Net National Income is Gross National Income or Gross National Product less 
depreciation. It is to be noted that National Income includes Net Factor Income Earned from Abroad 
also. While computing National Income only finished or final goods are considered as factoring 
intermediate goods used for manufacturing would amount to double counting. It includes taxes but 
does not include subsidies.
METHODS TO MEASURE NATIONAL INCOME
There are three methods of measuring the national income of a country. They yield the same result. 
These methods are:
 (1) The Product Method or Value Added Method.
 (2) The Income Method.
 (3) The Expenditure Method
 (1) The Product Method : The Product method measures the contribution of each producing 
enterprise in the domestic territory of the country. This method involves the following steps:
 (a) Identifying the producing enterprise and classifying them into individual sectors according 
to their activities.
 (b) Estimating net value added by each producing enterprise as well as each industrial sector 
and adding up the net value added by all the sectors.
  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 a 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 is added up are:
  (i) agriculture (ii) manufacturing (iii) construction (iv) transport and communication (v) banking 
(vi) administration and defence and (vii) distribution of income.
  Precautions for Product Method or Value Added Method
 (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.
Page 3


449
Economic and  
Business Environment
NATIONAL INCOME ACCOUNTING 
AND RELATED CONCEPTS
LESSON 2
450
CSEET Reference Reading Material - I
Economic and  
Business Environment
INTRODUCTION
National income is an uncertain term which is used interchangeably with national dividend, national 
output and national expenditure. On this basis, national income has been defined in a number of 
ways. In common parlance, national income means the total value of goods and services produced 
annually in a country.
In other words, the total amount of income accruing to a country from economic activities in a year’s 
time is known as national income. It includes payments made to all resources in the form of wages, 
interest, rent and profits.
National Income or Net National Income is Gross National Income or Gross National Product less 
depreciation. It is to be noted that National Income includes Net Factor Income Earned from Abroad 
also. While computing National Income only finished or final goods are considered as factoring 
intermediate goods used for manufacturing would amount to double counting. It includes taxes but 
does not include subsidies.
METHODS TO MEASURE NATIONAL INCOME
There are three methods of measuring the national income of a country. They yield the same result. 
These methods are:
 (1) The Product Method or Value Added Method.
 (2) The Income Method.
 (3) The Expenditure Method
 (1) The Product Method : The Product method measures the contribution of each producing 
enterprise in the domestic territory of the country. This method involves the following steps:
 (a) Identifying the producing enterprise and classifying them into individual sectors according 
to their activities.
 (b) Estimating net value added by each producing enterprise as well as each industrial sector 
and adding up the net value added by all the sectors.
  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 a 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 is added up are:
  (i) agriculture (ii) manufacturing (iii) construction (iv) transport and communication (v) banking 
(vi) administration and defence and (vii) distribution of income.
  Precautions for Product Method or Value Added Method
 (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.
451
Economic and  
Business Environment
Lesson 2 - National Income Accounting and Related Concepts
 (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) Expenditure Method : The expenditure approach measures national income as total spending 
on final goods and services produced within the nation during a 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. 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 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 a business on plants, government spending and net exports.
  Precautions for Expenditure Method
 (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.
 (3) Income Method : Income 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 
Page 4


449
Economic and  
Business Environment
NATIONAL INCOME ACCOUNTING 
AND RELATED CONCEPTS
LESSON 2
450
CSEET Reference Reading Material - I
Economic and  
Business Environment
INTRODUCTION
National income is an uncertain term which is used interchangeably with national dividend, national 
output and national expenditure. On this basis, national income has been defined in a number of 
ways. In common parlance, national income means the total value of goods and services produced 
annually in a country.
In other words, the total amount of income accruing to a country from economic activities in a year’s 
time is known as national income. It includes payments made to all resources in the form of wages, 
interest, rent and profits.
National Income or Net National Income is Gross National Income or Gross National Product less 
depreciation. It is to be noted that National Income includes Net Factor Income Earned from Abroad 
also. While computing National Income only finished or final goods are considered as factoring 
intermediate goods used for manufacturing would amount to double counting. It includes taxes but 
does not include subsidies.
METHODS TO MEASURE NATIONAL INCOME
There are three methods of measuring the national income of a country. They yield the same result. 
These methods are:
 (1) The Product Method or Value Added Method.
 (2) The Income Method.
 (3) The Expenditure Method
 (1) The Product Method : The Product method measures the contribution of each producing 
enterprise in the domestic territory of the country. This method involves the following steps:
 (a) Identifying the producing enterprise and classifying them into individual sectors according 
to their activities.
 (b) Estimating net value added by each producing enterprise as well as each industrial sector 
and adding up the net value added by all the sectors.
  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 a 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 is added up are:
  (i) agriculture (ii) manufacturing (iii) construction (iv) transport and communication (v) banking 
(vi) administration and defence and (vii) distribution of income.
  Precautions for Product Method or Value Added Method
 (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.
451
Economic and  
Business Environment
Lesson 2 - National Income Accounting and Related Concepts
 (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) Expenditure Method : The expenditure approach measures national income as total spending 
on final goods and services produced within the nation during a 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. 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 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 a business on plants, government spending and net exports.
  Precautions for Expenditure Method
 (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.
 (3) Income Method : Income 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 
452
CSEET Reference Reading Material - I
Economic and  
Business Environment
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 (sole proprietorship, partnerships and producers 
cooperatives).
  Precautions for Income Method
  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. are not to 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 the generation of income in the 
current year’s production of goods.
KEY CONCEPTS OF NATIONAL INCOME
Gross Domestic Product (GDP)
GDP is the total value of goods and services produced within the country during a year. This is calculated 
at market prices and is known as GDP at market prices. Dernberg defines GDP at market price as “the 
market value of the output of final goods and services produced in the domestic territory of a country 
during an accounting year.”
There are three different ways to measure GDP:
Page 5


449
Economic and  
Business Environment
NATIONAL INCOME ACCOUNTING 
AND RELATED CONCEPTS
LESSON 2
450
CSEET Reference Reading Material - I
Economic and  
Business Environment
INTRODUCTION
National income is an uncertain term which is used interchangeably with national dividend, national 
output and national expenditure. On this basis, national income has been defined in a number of 
ways. In common parlance, national income means the total value of goods and services produced 
annually in a country.
In other words, the total amount of income accruing to a country from economic activities in a year’s 
time is known as national income. It includes payments made to all resources in the form of wages, 
interest, rent and profits.
National Income or Net National Income is Gross National Income or Gross National Product less 
depreciation. It is to be noted that National Income includes Net Factor Income Earned from Abroad 
also. While computing National Income only finished or final goods are considered as factoring 
intermediate goods used for manufacturing would amount to double counting. It includes taxes but 
does not include subsidies.
METHODS TO MEASURE NATIONAL INCOME
There are three methods of measuring the national income of a country. They yield the same result. 
These methods are:
 (1) The Product Method or Value Added Method.
 (2) The Income Method.
 (3) The Expenditure Method
 (1) The Product Method : The Product method measures the contribution of each producing 
enterprise in the domestic territory of the country. This method involves the following steps:
 (a) Identifying the producing enterprise and classifying them into individual sectors according 
to their activities.
 (b) Estimating net value added by each producing enterprise as well as each industrial sector 
and adding up the net value added by all the sectors.
  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 a 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 is added up are:
  (i) agriculture (ii) manufacturing (iii) construction (iv) transport and communication (v) banking 
(vi) administration and defence and (vii) distribution of income.
  Precautions for Product Method or Value Added Method
 (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.
451
Economic and  
Business Environment
Lesson 2 - National Income Accounting and Related Concepts
 (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) Expenditure Method : The expenditure approach measures national income as total spending 
on final goods and services produced within the nation during a 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. 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 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 a business on plants, government spending and net exports.
  Precautions for Expenditure Method
 (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.
 (3) Income Method : Income 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 
452
CSEET Reference Reading Material - I
Economic and  
Business Environment
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 (sole proprietorship, partnerships and producers 
cooperatives).
  Precautions for Income Method
  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. are not to 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 the generation of income in the 
current year’s production of goods.
KEY CONCEPTS OF NATIONAL INCOME
Gross Domestic Product (GDP)
GDP is the total value of goods and services produced within the country during a year. This is calculated 
at market prices and is known as GDP at market prices. Dernberg defines GDP at market price as “the 
market value of the output of final goods and services produced in the domestic territory of a country 
during an accounting year.”
There are three different ways to measure GDP:
453
Economic and  
Business Environment
Lesson 2 - National Income Accounting and Related Concepts
 (a) The Product Method : In this method, the value of all goods and services produced in different 
industries during the year is added up. This is also known as the value added method to GDP 
or GDP at factor cost by industry of origin. The following items are included in India in this: 
agriculture and allied services; mining; manufacturing, construction, electricity, gas and water 
supply; transport, communication and trade; banking and insurance, real estates and ownership 
of dwellings and business services; and public administration and defence and other services 
(or government services). In other words, it is the sum of gross value added.
 (b) The Income Method : The people of a country who produce GDP during a year receive income 
from their work. Thus GDP by income method is the sum of all factor incomes: Wages and 
Salaries (compensation of employees) + Rent + Interest + Profit.
 (c) Expenditure Method : This method focuses on goods and services produced within the country 
during one year. GDP by expenditure method includes:
 1. Consumer expenditure on services and durable and non-durable goods (C).
 2. Investment in fixed capital such as residential and non-residential building, machinery, and 
inventories (I).
 3. Government expenditure on final goods and services (G).
 4. Export of goods and services produced by the people of the country (X).
 5. Less imports (M). That part of consumption, investment and government expenditure which 
is spent on imports is subtracted from GDP. Similarly, any imported component, such as raw 
materials, which are used in the manufacture of export goods, is also excluded.
Thus GDP by expenditure method at market prices = C+ I + G + (X – M), where (X-M) is net export which 
can be positive or negative.
GDP at Factor Cost
GDP at factor cost is the sum of the net value added by all producers within the country. Since the 
net value added gets distributed as income to the owners of factors of production, GDP is the sum of 
domestic factor incomes and fixed capital consumption (or depreciation).
Thus GDP at Factor Cost = Net value added + Depreciation. GDP at factor cost includes:
 (a) Compensation of employees i.e., wages, salaries, etc.
 (b) Operating surplus which is the business profit of both incorporated and unincorporated firms 
[Operating Surplus = Gross Value Added at Factor Cost—Compensation of Employees— 
Depreciation].
 (c) Mixed Income of Self- employed.
Conceptually, GDP at factor cost and GDP at market price must be identical/This is because the factor 
cost (payments to factors) of producing goods must equal the final value of goods and services at 
market prices. However, the market value of goods and services is different from the earnings of the 
factors of production.
In GDP at market price, indirect taxes are included and subsidies by the government are excluded.
Therefore, in order to arrive at GDP at factor cost, indirect taxes are subtracted and subsidies are 
added to GDP at market price.