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Methods of Calculating National Income

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Methods of Calculating National Income

National income can be measured using three primary methods: Production Method, Income Method, and Expenditure Method. Each method gives the same result but approaches the calculation from different angles.

1. Production Method (Value Added Method)

This method calculates national income by adding the value added at each stage of production.

Formula:

GDP=∑(Value of Output−Intermediate Consumption)

GDP = \sum (Value\ of\ Output – Intermediate\ Consumption)

Example:

A farmer grows wheat and sells it for ₹20. A flour mill converts it into flour and sells it for ₹40. A bakery uses the flour to make bread and sells it for ₹60.

  • Value added at each stage:
    • Farmer: ₹20
    • Flour Mill: ₹40 – ₹20 = ₹20
    • Bakery: ₹60 – ₹40 = ₹20
  • Total GDP (sum of value added): ₹20 + ₹20 + ₹20 = ₹60

This method is widely used in manufacturing and industrial sectors.

2. Income Method

This method calculates national income by adding all incomes earned by factors of production (land, labour, capital, and entrepreneurship).

Formula:

GDP=Wages+Rent+Interest+Profit

GDP = Wages + Rent + Interest + Profit

Example:

Consider a company with the following payments in a year:

  • Wages to employees = ₹50 crore
  • Rent for office space = ₹10 crore
  • Interest on loans = ₹15 crore
  • Profits = ₹25 crore

Total National Income (GDP) = ₹50 + ₹10 + ₹15 + ₹25 = ₹100 crore

This method is useful in analyzing income distribution in an economy.

3. Expenditure Method

This method calculates GDP by adding all spending on final goods and services.

Formula:

GDP=C+I+G+(X−M)GDP = C + I + G + (X – M)

where:

  • C = Private consumption expenditure
  • I = Investment expenditure
  • G = Government expenditure
  • (X – M) = Net exports (Exports – Imports)

Example:

If a country’s expenditures are:

  • Consumption (C): ₹300 crore
  • Investment (I): ₹150 crore
  • Government Spending (G): ₹200 crore
  • Exports (X): ₹50 crore
  • Imports (M): ₹30 crore

GDP = ₹300 + ₹150 + ₹200 + (₹50 – ₹30) = ₹670 crore

This method is widely used in macroeconomic analysis and policy decisions.

Which Method is Used in India?

India uses a combination of all three methods to calculate national income, depending on the sector:

  • Agriculture & Industry → Production Method
  • Services Sector → Income Method
  • Macroeconomic Analysis → Expenditure Method

Statement-based MCQs

MCQ 1
Which of the following statements is/are correct regarding the methods of calculating national income?

  1. The Production Method adds up the value of all final goods and services produced in an economy.
  2. The Income Method includes wages, rent, interest, and profit in its calculation.
  3. The Expenditure Method accounts for total spending in an economy, including savings.

a) 1 and 2 only
b) 2 and 3 only
c) 1 and 3 only
d) 1, 2 and 3

Tap here for Answer
Answer: a) 1 and 2 only
Explanation:

  • Statement 1 is correct — the Production Method calculates value added at different stages of production.
  • Statement 2 is correct — the Income Method considers wages, rent, interest, and profit.
  • Statement 3 is incorrect — savings are not part of GDP calculation; only actual spending is counted.

MCQ 2
Which of the following is counted under the Income Method of national income calculation?

  1. Salaries paid to government employees
  2. Dividends earned by shareholders
  3. Consumer spending on groceries

a) 1 only
b) 1 and 2 only
c) 2 and 3 only
d) 1, 2 and 3

Tap here for Answer
Answer: b) 1 and 2 only
Explanation:

  • Salaries and dividends are factor incomes counted in the Income Method.
  • Consumer spending on groceries is part of the Expenditure Method, not the Income Method.

MCQ 3
Which of the following statements correctly describe the Expenditure Method of calculating national income?

  1. It considers government spending as a key component.
  2. It includes imports in the GDP calculation.
  3. It excludes private investments from national income.

a) 1 and 2 only
b) 1 only
c) 2 and 3 only
d) 1, 2 and 3

Tap here for Answer
Answer: a) 1 and 2 only
Explanation:

  • Statement 1 is correct — Government spending is part of the formula GDP = C + I + G + (X – M).
  • Statement 2 is correct — Imports are included but subtracted from GDP.
  • Statement 3 is incorrect — Private investment is included under I (Investment Spending).

MCQ 4
Which of the following correctly distinguishes GDP from GNP?
a) GDP includes both domestic and foreign income, while GNP excludes foreign income.
b) GDP measures only the production within the country, while GNP includes earnings from citizens working abroad.
c) GDP is calculated using the Expenditure Method, while GNP is calculated using the Income Method.
d) GDP is always higher than GNP for every country.

Tap here for Answer
Answer: b) GDP measures only the production within the country, while GNP includes earnings from citizens working abroad.
Explanation:

  • GNP = GDP + Net Factor Income from Abroad.
  • Statement a is incorrect — GDP does not include foreign income.
  • Statement c is incorrect — Both GDP and GNP can be calculated using different methods.
  • Statement d is incorrect — Some countries have higher GNP than GDP (e.g., Philippines, due to high remittances).

MCQ 5
Which of the following is a limitation of the Production Method of national income calculation?
a) It does not consider depreciation.
b) It underestimates the contribution of the services sector.
c) It does not account for government spending.
d) It includes illegal economic activities.

Tap here for Answer
Answer: b) It underestimates the contribution of the services sector.
Explanation:

  • The Production Method is more useful in manufacturing and agriculture but less effective in capturing service sector contributions, where value-added is difficult to measure.
  • Statement a is incorrect — Depreciation is considered when calculating NDP.
  • Statement c is incorrect — Government spending is covered under Expenditure Method.
  • Statement d is incorrect — Illegal activities are not included in national income.

 

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