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Income Method of Measuring National Income

As explained by the circular flow of income in an economy, every act of production of a good or service generates a corresponding flow of factor incomes to the factors of production who produce those goods and services. 

The Income method measures the national income by adding up the factor incomes of the factors of production. To find the National Income all the factor incomes generated in the economy must be summed up. A factor income is basically a reward which a factor earns in exchange for providing his/her factor services. A labourer receives wages in return for the work he does for his employer. 

The four main factors of production are: land, labour, capital and entrepreneurship and their corresponding remunerations are rent, wages, interest and profit. Adding up all the rent, wages, interest and profit generated in the economy in a given year, gives the total income in the economy for that year. Another type of factor income generated is the Mixed Income, which is also added in to get the National Income.

The National income computed in this way shows the distribution of income among the different income groups in the economy.

Steps for Calculating National Income

The National Income is calculated by the following steps

Step 1. Classification of the production enterprise:

As a first step, the different production units in the economy are identified and classified into Primary, Secondary and Tertiary Sector

Step 2. Identifying and Estimating the factor Incomes

In this step the factor incomes arising to the four factors of production are estimated and are grouped into the four categories of wages, rent, interest and profit and mixed income. 

Components of Factor Income

The factor incomes generated in the economy can be divided into three components

1. Compensation of Employees

This includes the income paid by the employer to his/her employees in exchange of their factor services. It includes both monetary and non-monetary benefits given by the employer to his/her employees. It is further composed of three parts


·   Wages given in Cash: It includes the monetary payments made to employees such as their salaries, bonus, commission, Dearness Allowance. This type of monetary payments can be in cash or deposited into the employee’s account.

·   Wages in kind: Employees also receive certain non-monetary benefits from their employees like fully furnished home, health and education facility etc. An estimate of the value of these benefits is calculated to be added in the national income.

·   Employers’ contribution to Social Security schemes: There are certain social security schemes in which the employer contributes such as Employees Provident Fund, Gratuity, retirement pension. 

2. Operating Surplus

Operating surplus includes the other factor payments such rent, interest and profit.

a)  Rent: Rent is that factor income arising out of the ownership of fixed assets like land, buildings and property. Rent includes both the actual rent (arsing out of land that is rented out to others) and imputed rent (arising on self-owned land and calculated as the market value of that land).

b)  Interest: Funds may be loaned to production enterprise by people, banks etc to produce goods and services. The interest income arising out of such loanable funds is a part of national income. It is to be kept in mind that only such loans and lending is included which is used for a producing a good or a service i.e for productive service which add to the flow of goods and services in the economy. 

    Therefore interest arising out of certain type of loans such as consumer loans, public debt (money owed by government to the public) are not included as these are transfer payments (one sided payments) for the purpose of consumption.

c)  Profit: The reward or income that an entrepreneur gets in return of his services of producing goods and services is called profit. Profit is the residual income left with the entrepreneur after factor incomes like wages, rent and interest has been paid to the factors of production. The entrepreneur can divide his/her profit in three parts:

·   Corporate Tax: It is the tax paid by the entrepreneur to the government out of the profit earned.

·   Dividend: Some part of the profit is also distributed to the shareholders (who own the shares of the company) of the company as dividend. People who own the shares of that company get a share in the profits as well.

·   Earning that are Retained: It is that part of the profit which remains after giving corporate tax to the government and dividend to shareholders. This part of the profit is also known as savings of the entrepreneur and can be used as the entrepreneur desires. It can be used to reinvest in the company or used as reserve to meet market uncertainties.

Operating Surplus = Rent + Interest + Profit

Profit = Corporate Taxes + Dividend + Retained Earnings

3. Mixed Income

There are also people who are self-employed or run unincorporated (not registered as a legal corporation) business with their own set of factors of production. In such a case they are not paid a salary or rent from others as these people are not hired from the market. Rather they work for themselves and the income which arises from their work is classified under Mixed income, as the elements of their income cannot be separated into different heads as rent, interest etc. Their income is a mixture of these factor incomes for example farmer using his own land and labour and tools, small retailers, tailor, consultants.

Step 3 Calculating the Total Domestic Income

      The Domestic Income is calculated by adding up all the factor incomes. The National Income identity we get by this method is the NDPFC.  To get national income i.e NNPFC, we add the Net Factor Income from Abroad.

Why do we get NDPFC and not GDPMP by this method?

Since, factor incomes are devoid of depreciation, there no Gross Product here. Hence, we get Net Income. Also factor incomes are not imposed with indirect taxes and subsidies, therefore, we get national income at factor cost. 

Precautions while Calculating Income by National Income Method

Certain points should be kept in mind while calculating the National Income by this method

1. Transfer Payments

Only the factor incomes generated by providing productive services are included in the National Income. Transfer Incomes such as scholarships, charity, unemployment allowance, old age pension are not included in the National income, as these are one-sided payments given without rendering any productive services. Retirement Pension however, is included in factor income as this is an earned income from the place where a person has worked. Whereas, old age pension, is a one way payment and thus is counted under transfer payments. 

2. Second-hand goods: The value of second hand goods is not included in the estimation of national income but the commission or bonus or brokerage earned form a part of national income as this commission is earned for providing productive services.

Similarly, income arising out of sale of stocks and bonds in not included in the estimation of national income,but the brokerage or commission earned is included as it is a reward for rendering a service. 

3. Windfall Gains: Income arising out of windfall gains such as lottery, inheritance, rise in property prices is not included in the national income as no productive activity takes place in response to the generation of this income.

4. Income arising from illegal activities like smuggling, black-marketing etc is not included as these are deemed unlawful by the governments.

5. Rent on self-occupied properties calculated as imputed rent is included in the national income.

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