There are three approaches to the Measurement of National Income and these are the Output Approach, the Income Approach and the Expenditure Approach.
The output approach to the measurement of national income measures the monetary value of all goods and services produced by the various sectors of the economy. In using this method, care must be taken to ensure that double counting is avoided. That is, no output or product must be counted twice. For instance, in the manufacturing sector, the values of the raw materials must be subtracted from the value of the final product. The typical example is the cost of cakes. It is only the value added to the flour to change it to cake that will be measured. The reason is that including the cost of flour and sugar will lead to counting these twice over. The value added is therefore the price of the cake minus its production cost. Another name for this method of measuring the national income is the product method.
The Income Approach
The reward that accrues to all the four factors of production when used in economic activities is known as income earned by them. The summation or addition of these incomes gives the national income of a country. These are all interests, rents, wages and salaries earned by capital, entrepreneur, land and labour, The incomes include all incomes earned by firms, individuals and government parastatals that were involved in economic activities within a year. This is also equal to the national income measured by the use of the output method. In using the income approach. care must be taken to avoid double counting hence all transfer payments in the form of pension to the aged, gifts, dividends paid to shareholders, pocket money given to students. etc., must be deducted. These are known as transfer incomes while transfers are deducted products and services consumed by owners of business incomes.
In summary therefore, the GNP is equal to the addition of all incomes such as interests, profits, rents, wages and net income from abroad, minus transfer incomes or payments.
GNP = I + P + R + S+ NY (a) – TY
Where GNP = Gross National Product
I = Interest
P = Profits
R = Rents
W = Wages
S = Salaries
NY(a) = Net income from abroad and
TY = Transfer Income
This approach gives the GDP or GNP at factor, because all the cost or incomes or the various factors of production are added up to calculate the GDP at market prices, taxes are added and subsidies subtracted.
The Expenditure Approach
Assuming that all income earned by the factors of production is spent on the consumption of all goods and services produced; then the total income earned must be equal to the total expenditure on the consumption of and investments on goods and services produced. Therefore, the income earned by individuals, firms and government will be equal to the summation of their total expenditure on consumption and investment within a specified time period, usually a year. Note that consumption and investment refers to final consumption and final investments respectively. For example in the case of the cake, it is only the price of the cake minus its production cost that is considered as the final expenditure on the production of the cake. The prices of flour and other ingredients added must be excluded, so as to avoid double counting. This is given as:
Y = C + I + G + P + X – M
Where Y = National Income
C = Consumption expenditure
I = Investment expenditure
G = Government Expenditure on consumption and investment
P = Net Property Income Property income from abroad Property income paid
X = Exports
M = Imports
Problems of the Output Method
The use of the market prices to evaluate the goods and services produced makes. it difficult to determine the actual value of the following:
(i) Government services which are collectively used by everybody.
(ii) Services provided by housewives.
(iii) Products and services consumed by the producers themselves.
(iv) The construction work and maintenance services done on a landlord’s or landlady’s house by themselves.
Problems of the Income Method
(i) In West Africa, many people are self-employed as farmers, tailors, traders, etc., and this makes the estimation of their income difficult to ascertain.
(ii) It is not easy to determine the net income from abroad. The difference between the income received from abroad and that remitted abroad is difficult to get.
(iii) The calculation of the national income using income approach also faces the problem of owner occupied houses. The value of the estimated rents for such houses have to be determined and added to the national income estimates because if these houses had been rented out to tenants, the rents collected would have been an income to their owners.
(iv) Almost all corporations or companies do not pay out everything earned by them as dividends to their shareholders. The part of the profit not paid out as dividends must be added to the personal income to get the Gross National Income at factor cost. The Net National Income (NNI) is arrived at after deducting the depreciation on fixed assets from the Gross National Income (GNI). i.e. NNI = GNI – Depreciation.
(v) It is difficult to determine the actual depreciation amount that should be deducted from the firm’s income or the amount of government subsidies that should be added back.
Expenditure Approach Problems
This method suffers from an inadequate supply of correct data about individual expenditure especially within the rural areas.