Identify and Explain the following concepts
1.Explain the practical difficulties involved in the measurement of national income.
Following are the difficulties in the measurement of national income:
Problem-related to double counting: One of the major problems involved in the estimation of national income by the value-added method is the problem of double counting. Double counting refers to a situation where the value of a good is taken into account (counted) more than once. Such a problem occurs because, for every producer, the commodity he sells is the final commodity. Thus, if the value of the good is taken into account every single time, it leads to the estimating of the value of the product more than once.
Estimation regarding depreciation: During the process of production, along with the raw materials and inputs, various fixed assets such as machinery, tools, etc. are also used. However, during the course of production, the fixed assets undergo wear and tear. This wear and tear reduces the value of the fixed assets of business entities. Since depreciation is based on various assumptions and is subjective in nature, it is difficult for an individual to correctly assess the deduction to be made for depreciation.
Self-consumption: At times, the producer or firm keeps a certain portion of the output for self-consumption. Such a portion of production that is retained for self-consumption should be included in the estimation of national income, but it is difficult to calculate such consumption and production.
Windfall gains and capital gains: Windfall gains such as lotteries and capital gains are unearned income and are not included in the estimation of the national income. However, these activities very much add to the national product.
Valuation of inventories: Raw materials, intermediate goods, semi-finished and finished products in the stock of the producers are known as inventories. Any mistake in measuring the value of inventory will distort the value of the final production of the producer. Therefore, the valuation of inventories requires careful assessment.
Illiteracy and ignorance: Due to ignorance and illiteracy, small producers do not keep an account of their production. So they cannot give information about the quantity or value of their output
2. Explain the income method and expenditure method of measuring national income.
Income Method: This method of measuring national income is also known as the factor cost method. This method estimates national income from the distribution side.
GNP can be treated as the sum of factor incomes, earned as a result of undertaking the economic activity, on the part of resource owners and reflected in the production of the total output of goods and services during any given time period.
Thus, GNP, according to income method, is calculated as follows:
NI = Rent + Wages + Interest + Profit + Mixed Income + Net income from abroad.
NI = R + W + I + P + MI + (X–M)
Expenditure Method: This method of measuring national income is also known as the Outlay Method. According to this method, the total expenditure incurred by the society, in a particular year, is added together. Income can be spent either on consumer goods or on capital goods. Thus, we can get national income by summing up all consumption expenditure and investment expenditure made by all individuals, firms as well as the government of a country during a year. Thus, GNP according to the expenditure method, is calculated as follows:
NI = C + I + G + (X–M) + (R–P)