Three Methods of calculating National Income: Value added Method, Expenditure Method and Income Method

National Income refers to the value of goods & services produced by a nation during a particular financial year. Therefore, it is the net result of all the economic activities that take place during a financial year and is valued in monetary terms. It includes payments made to various resources either in form of rents, wages, interests and profits. A country’s progress can be estimated by the growth of its national income.

Methods of Calculating National Income

National income (NY) can be computed using any of the three below-stated methods:

1. Value added method or Product method
2. Income method
3. Expenditure method

1. Value Added Method/ Product Method 

Value Added is a method of calculating the National Income of an economy in different production phases in a circular flow. The production process of a good or service involves different production units. The value added method shows the value added or contribution of such units. 

Every enterprise of industry adds some value to a final product, and for its production, it purchases some intermediate goods from other firms. To calculate the National Income of an economy, the value added by each of these individual firms to the final product is summed up. Other names of Value Added Method are Product Method, Inventory Method, Commodity Service Method, Industrial Origin Method and Net Output Method. To calculate the National Income of an economy, first of all, the Gross Value Added is calculated. The formula for calculating Gross Value Added(GVA_MP ) is 

GDP_MP = ∑GVA_MP

OR

GDP_MP = GVA_MP of Primary Sector + GVA_MP of Secondary Sector + GVA_MP of Tertiary Sector

The formula for calculating National Income through Value Added Method is,

National Income or NNP_FC = GDP_MP – Depreciation – Net Indirect Taxes + NFIA

Example 1: 

Determine the following with the help of the given information:

i) Value of Output

ii) Net Value Added at Factor Cost

Solution:

i) Value of Output = Sales + Increase in Unsold Stock

Value of Output = 12,800 + 1,000

Value of Output = ₹13,800 Crores

ii) Net Value Added at Factor Cost (NVA_FC) = Sales + Increase in Unsold Stock – Purchase of Raw Materials – Depreciation – (Indirect Tax – Subsidies)

NVA_FC = 12,800 + 1,000 – 3,400 – 400 – (900 – 200)

Net Value Added at Factor Cost (NVA_FC) = ₹9,300 Crores

Example 2:

Firm A buys from K inputs worth ₹600 Crores and sells to firm B goods worth ₹1,500 Crores and to firm C worth ₹760 Crores. Firm B buys from L inputs worth ₹300 Crores and sells to firm C goods worth ₹1,200 Crores and finished goods worth ₹2,500 to the households. Firm C buys from M inputs worth ₹100 Crores and sells finished goods worth ₹3,250 to the households. Calculate Value Added by firms A, B, and C. Also calculate Gross Domestic Product at Market Price.

Solution:

Value Added by Firm A = GVA_MP of A = ₹1,660 Crores

Value Added by Firm B = GVA_MP of B = ₹1,900 Crores

Value Added by Firm C = GVA_MP of C = ₹1,190 Crores

GDP_MP = ∑GVA_MP

GDP_MP = 1,660 + 1,900 + 1,190

GDP_MP = ₹4,750 Crores

2. Income Method 

The Income Method calculates the National Income of an economy based on the idea that whatever the firm earns in exchange for goods and services is used to make the factor payments. In other words, to calculate the national income of an economy through the Income Method, the incomes received by residents of a country for the productive services provided by them during a year are added together. The incomes for the productive services or factors of production are received by the residents in the form of profits, wages, interest, rent, etc. Other names for Income Method are Distributive Share Method and Factor Payment Method. The formula for calculating National Income by Income Method is

National Income or NNP_FC = NDP_FC or Domestic Income (Compensation of Employees + Rent and Royalty + Interest + Profit + Mixed Income) + NFIA

Example 1:

Calculate Operating Surplus with the help of the following data:

Solution:

Operating Surplus = Sales – Intermediate Consumption – Compensation of Employees – Net Indirect Taxes – Consumption of Fixed Capital – Mixed Income

Operating Surplus = 5,000 – 500 – 900 – 340 – 160 – 350

Operating Surplus = ₹2,750 Crores

Example 2:

Calculate National Income with the help of the following data:

Solution:

National Income (NNP_FC) = Compensation of Employees + Operating Surplus + Mixed Income of Self-Employed + Net Factor Income from Abroad

NNP_FC = 14,000 + 4,500 + 17,200 + 400

National Income (NNP_FC) = ₹36,100 Crores

Note:

1. Wages in Kind are already included in the Compensation of Employees; therefore, it is not added to National Income.

2. Gross Domestic Fixed Capital Formation is also not included in the National Income as it is a part of the Expenditure Method.

3. Expenditure Method 

The Expenditure Method of calculating National Income takes the final expenditures of an economy into consideration. The factor income earned by different factors of production is spent by the different sectors of an economy in the form of expenditure on the purchase of goods and services manufactured by the firms. Under this method, all these final expenditures incurred on the purchase of goods and services by the government, households, foreigners, and business firms are added together. Another name for the Expenditure Method is Income Disposable Method. To calculate the National Income of an economy, first of all, the sum total of all the final expenditures is determined using the formula,

GDP_MP = ∑Final Expenditure

OR

GDP_MP = Private Final Consumption Expenditure (PFCE) + Government Final Consumption Expenditure (GFCE) + Gross Domestic Capital Formation (GDCF) or Domestic Investment + Net Exports (X – M)

The formula for calculating National Income through Expenditure Method is,

National Income or NNP_FC = GDP_MP – Depreciation – Net Indirect Taxes + NFIA

Example 1:

Calculate GDP at MP with the help of the following data:

Solution:

GDP_MP = Private Final Consumption Expenditure + Government Final Consumption Expenditure + Gross Fixed Capital Formation + Change in Stock + (Exports – Imports)

GDP_MP = 1,450 + 400 + 500 + 300 + (800 – 700)

GDP_MP = ₹2,750 Crores

Example 2: 

Calculate Gross Fixed Capital Formation from the following information:

Solution:

Gross Fixed Capital Formation = GDP_MP – Private Final Consumption Expenditure – Government Final Consumption Expenditure – Net Exports – (Closing Stock – Opening Stock)

Gross Fixed Capital Formation = 3,000 – 1,200 – 500 – (-) 40 – (150 – 250)

Gross Fixed Capital Formation = ₹1,440 Crores