National Income can be measured by different methods. Before learning the methods, there is a need to see the flow of income between the different players who take part and contribute to the National Income. There are four players namely, individuals or households, business firms or investors, Government and foreign sector. For the sake of simplicity, we consider only the first and second.

The diagram shows circular flow of income between households and business firms. The upper part shows the supply side of economy and the lower part shows the demand side of the economy.

In the upper part, the households supply factors of production viz.,labour, land,  capital and entrepreneur to business firms to produce goods and services. In return, the business firms gives wage, rent, interest and profit to labour, land, capital and entrepreneur respectively.

The wage, rent, interest and profit are expenditure to business firms but income to households. So one’s income is other’s expenditure. Hence it is evident that the expenditure of one player and the income of another player are equal. So National Income can be calculated by compiling of income of all or expenditure of all. The calculation of National Income by compiling income of household is called Income Method.

The bottom of the figure shows the flow of goods and services that are produced by business firms and demanded by the people. For the flow of goods and services produced and supplied by business firm, households pay money. Here, the value of goods and services produced (price x quantity) is equal to the expenditure incurred by households on purchase of those goods and services. Both are equal. So, the National Income can be calculated by calculating the total value of all goods and services or by compiling total expenditure incurred by the people. The former is called Product Method (or) Output method (or) Production method. The latter is called the Consumption Method (or) Expenditure Method.

1. PRODUCT METHOD (OR) OUTPUT METHOD (OR) PRODUCTION METHOD

In this method, the National Income is compiled by calculating the gross value of final goods & services produced in a country in one year. GDP is a concept of value added. Gross value added is the difference between output and intermediate consumption. In fact, output minus intermediate consumption or input is called as net value added. But here, we include the tax also in valuation. So it is called gross value.

2. INCOME METHOD

Under Income Method, the National Income is calculated by compiling income of factors of production viz., labour, land, capital and entrepreneur.

National Income = Total Wage + Total rent + Total interest +Total profit

The approach above also mentioned is a Macro economical theoretical approach. In the Indian context, it is slightly different as per 1993 SNA (System of National Accounts) framework. It is the total of the following.

GDP = Compensation of employees + Consumption of fixed capital + (Other taxes on Production – Subsidies on production) + Gross operating surplus

Compensation of employees means the salaries paid in cash and kind and other benefits provided to employees engaged in production of goods and services. To put it simply it is ‘wage’.

Consumption of fixed capital means wear and tear of machinery. These are replaced with new parts or machinery. It adds to income of machinery and spare parts producers. So, it is added here.

Other taxes on production minus the subsidies are the net tax on production. Gross operating surplus is the balance of value added after deducting the above three components. It goes to pay rent of land and interest of capital.

3. CONSUMPTION METHOD (OR) EXPENDITURE METHOD

In Consumption Method (or) Expenditure Method, the consumption expenditure of consumers (C), consumption expenditure of investors or entrepreneur which is called investment (I) and consumption of Government (G) is added.

GDP = C + I + G

This formula can be extended as follow, as per 1993 SNA framework.

GDP = Household final consumption expenditure + Consumption expenditures incurred by General Government and NPHIs + Saving + Gross capital formation

Household final consumption expenditure consists of expenditure of resident households on consumption of goods or services.

Consumption expenditures incurred by General Government consists of expenditure on welfare scheme and others and NPHIs (Non-profit institutions serving household) are similar to expenditure incurred by non-profit organizations like NGOs.

Saving is the amount that is not spent on consumption, and is saved.

Gross capital formation is the investment made on fixed assets.

SUITABILITY OF METHOD

No method is universally applicable. The product method is suitable to calculate income from primary (agriculture, forestry etc.) and secondary (industry, mining etc.) sectors. In these sectors, tangible products are produced. So, it is easy to count and multiply them with the price. In tertiary (service) sector, no tangible products are produced. So product method is difficult. Hence, it is better to use product method in primary and secondary sectors and income method in tertiary sectors.

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