- Product Method or Value added Method
- Income Method
- Expenditure Method
Product Method/ Value added Method
Product method is that method, which measures domestic money by estimating the contribution of each enterprise to production in the domestic territory of the country in an accounting year.
Product method or Value added method is also known as Industrial Origin Method or Net output Method or Inventory Method or Commodity Service method.
Value added is the difference between value of output of an enterprise and the value of its intermediate consumption.
Value added= Value of Output- Value of Intermediate consumption
Value of Output= Sales (if entire output of the year is sold during the year)
Value of output= Sales + Change in Stock
Value added=GDP mp
To calculate the national income by this method, we need to identify and classify productive enterprises in three categories:
- Primary Sector
- Secondary Sector
- Tertiary Sector
Primary Sector includes agriculture and allied activities such as animal husbandry fisheries, forestry, and mining etc. The Secondary Sector includes manufacturing sector which converts the raw materials into finished products. The Tertiary Sector is the service sector which includes services such as banking, insurance, transport, communication and trade etc.
After classification, net value added in each sector is calculated in an accounting year. Gross value added is found by deducting the intermediate consumption from the value of production generated.
Precautions used in production or value added method
- The sale and purchase of old goods and included but the commission charges by agents in their transaction is a part of national income.
- Imputed value of production for self-consumption is taken into Because, these goods are like those produced for the market.
- Imputed rent on the owner occupied house is Because all houses have rental value, no matter these are self occupied or rented out.
- Value of intermediate goods is not included into the estimation of national income.
- Services for Self-consumption are not considered while estimating value Because it is difficult to estimate their market value like services of housewives.
- Income from illegal activities is not included in national income.
This method is also known as factor cost method. Under this method, national income is obtained by adding the incomes such as rent, wages, interest and profit received by all persons in the country during a year. In practice, the income figures are obtainable mostly from income tax returns, books of accounts and published accounts. To this, net income from foreign trade and net investment from abroad should be added.
According to income method, the net income payments received by all citizens of a country in a particular year are added up. The net incomes earned by the factors of production in the form of rent, wage, interest and profit aggregated but incomes in the form of transfer payments are not included in the national income.
NDPFC= Compensation of Employees + Operating Surplus + Mixed Income
Components of Income Method
Compensation of Employees: It includes Wages and salaries in cash, Employers contribution to social security scheme, Pension on retirement, Bonus, Allowances etc.
Operating Surplus: It includes rent and royalty, interest, profit (dividend +corporation tax+ undistributed profits).
Mixed Income: It is the income of the self employed persons such as farmers, shopkeepers, doctors etc. They generate goods and services with the help of their own land, capital and labour and thus earn mixed income in the form of interest, profit rent and wages. This income is included in national income.
In India, this method is used for adding up the net income arising from trade, transport, public administration, professional and domestic services. Due to lack of popularity of personal accounting practices, this method cannot be fully used or practiced. This method is used only for some minor sectors. None of these methods alone will give a more correct figure.
- All transfer income which does not represent earnings from productive services such as pension, scholarship, unemployment doles, lottery prize, etc. are not to be included as they are not earned by participating in the current production.
- All unpaid services like services of a housewife are to be excluded.
- All capital gains or loss (buying an old house, or resale of property) should be excluded.
- Direct tax, revenue to the government should be subtracted from the total income as it is only transfer of income.
- Undistributed profits of companies, income from government should be added.
- Subsidies given by the government should be deducted from profits of the subsidized industry.
- Income from sale of second hand goods is not included in national income.
- Income from sales and purchase of old shares is not included in national income.
Expenditure method is the method which measures final expenditure on gross domestic product at market price during an accounting year. Final expenditure is equal to the gross domestic product at market price. This is also called “Income Disposal Method”, Consumption and Investment Method”.
According to the expenditure method, the total expenditure incurred by the society in a particular year is added together. According to these methods total expenditure equals the national income. Following items are included in it:
- Private Final Consumption expenditure
- final consumption expenditure
- Gross domestic capital formation
- Change in stock
- Net exports
1. Private Final Consumption Expenditure
It consists of expenditure on durable goods (e.g., furniture, cars, etc), non-durable goods (e.g., food items and toiletries) and services (e.g., hotels, educational institutions, hospitals, public transport, etc.,) by the household consumers.
The figures of private consumption expenditure may be collected from retail trade activities during an accounting period.
But the purchases made by non-residents and foreign visitors should be deducted from the final consumption expenditure in the domestic market whereas direct purchases made by resident households abroad during foreign travel should be included in consumption expenditure.
2. Government Final Consumption Expenditure
The government final consumption expenditure refers to the final consumption expenditure by the general government and it can be arrived at by summing up (a) value of net purchases in the domestic market, (b) net purchases abroad.
3. Gross Fixed Capital Formation
If consists of (a) Business fixed Investment, (b) Govt. Fixed Investment, (c) Investment on residential construction.
4. Change in Stock as Inventory Investment
Change in stock is the difference between the opening stock and closing stock. All enterprises and trading companies incur expenditure on stock of raw materials; semi finished goods or finished goods.
5. Net Exports of Goods and Services
It is the difference between the value of exports and imports of a country during an accounting period. What the foreigners spend on a country’s exports is the part of expenditure on the Gross domestic product.
Precautions used in Expenditure method
- Only expenditure on current final goods should be included so expenditure on second hand goods must not be added in aggregate expenditure.
- The intermediate expenditure also must not be included as it leads to double counting.
- Expenditure on transfer payments should not be taken account of.
- Gross domestic capital formation already has in it the replacement of machines therefore these two items should not be separately included in aggregate expenditure.
- Expenditure on financial transactions, e.g., shares and bonds should not be included because these transactions do not add to the flow of goods and services but only change the ownership of financial assets.
- Only expenditure on final goods and services should be included in aggregate expenditure.
- The aggregate expenditure got by adding up various components includes in itself the cost of Thus, we have the concept of so as to arrive at the Net Domestic Product at market price; depreciation should be deducted from it.