5.
Explain problems of calculating National income
1. Types of Goods and Services:
The kinds of goods and services which should be included in national income pose a problem.
Goods and services having money value are included in the national income but there are goods and
services which may have no corresponding flow of money payments.
The difficulty is whether these services should be included in national income and how to measure
their money value, e.g., a paid maid servant’s services are included in the national income but later
when she marries the master, she is not paid any more, though she continues to perform the services.
There is, thus, a reduction in the national income.
2. Problems of Double Counting:
Another difficulty is of double counting usually associated with the inventory method. Double
counting implies the possibility of a commodity like raw material or labour being included in national
income more than once, e.g., a farmer sells maize worth rupees two hundred to a mill-owner, the mill
owner further sells the maize flour to a wholesale dealer, who further sells it to consumer; if we
calculate it at every stage, its money value will increase to eight hundred rupees but actually the
increase in national income has been to the extent of two hundred rupees only.
The best way to avoid this difficulty is to calculate only the value of all goods and services that enter
into final consumption. The problem of differentiating intermediate and final products is very
complex and acute in the computation of national income. For example, expenditure incurred on the
purchase of goods and services by the government like expenditure on wages and salaries of
government employees who perform services like police, military, fire protection etc. are all included
in GNP estimates.
3. Excluded Market Transactions:
Certain transactions that take place in the market are excluded from the computation of
national income because they violate the general rule for the recognition of income—the
good or service must be currently produced and must use up currently available scarce
resources. Many transactions are such that represent merely the transfer of wealth (or claims
to wealth) or the exchange of commodities produced in some previous accounting period.
4. Problem of Imputed Values:
There are certain goods and services which do not appear in or cannot be brought to the
market. In such cases we have to impute values to them. It means to give or to fix their
values, in case they had been brought to the market. The procedure although very logical yet
is beset with number of practical difficulties because the task of imputing or fixing values is
not easy. But, values, once they are imputed or fixed are included in the national income
accounts.
Crops raised on the farm like wheat, rice, etc. and consumed by the farmer and his family on
the farm, person living in his own house, services rendered by commercial banks, insurance
companies and other financial institutions, ‘fringe benefits’ enjoyed by the well paid top
business executives of big companies and corporations like a managing director—receiving in
addition to his salary, ‘fringe benefits like free residence, future, conveyance, medical
allowances etc.
5. Inventory Adjustments:
Inventory adjustments i.e., changes in the stock of capital goods or final products are also to
be taken into account while computing national income. If a jute mill adds to its inventory of
jute products during the year, it represents an increase in output and must, therefore, be
included in GNP. The difference between the officially published figures and the figures
obtained from the business accounting data calls for inventory valuation adjustment. On
account of the change in the physical volume of inventories and the change in the prices at
which these inventories are valued by business units, inventory valuation adjustment
becomes essential.
6. Depreciation:
Depreciation implies a reduction in the value of capital stock or capital goods due to wear
and tear, constant use etc. During the process of production the wear and tear or capital
consumption occurs, resulting in, at the same time, a decline in the relative efficiency of the
plant and equipment on account of obsolescence. However, the problem of correctly
estimating depreciation is equally a difficult task e.g., a machine may be used more
intensively in one year than the other. But the rate of depreciation remains the same, though
it should differ between two years. Again, the depreciation of similar equipment may differ
between two business units.
6.
The expenditure approach attempts to calculate GDP by evaluating the sum of all final good
and services purchased in an economy. The components of U.S. GDP identified as “Y” in
equation form, include Consumption (C), Investment (I), Government Spending (G) and Net
Exports (X – M).
Y = C + I + G + (X − M) is the standard equational (expenditure) representation of GDP.
“C” (consumption) is normally the largest GDP component in the economy,
consisting of private expenditures (household final consumption expenditure) in the
economy. Personal expenditures fall under one of the following categories: durable
goods, non-durable goods, and services.
“I” (investment) includes, for instance, business investment in equipment, but does
not include exchanges of existing assets. Spending by households (not government) on
new houses is also included in Investment. “Investment” in GDP does not mean
purchases of financial products. It is important to note that buying financial products
is classed as ‘ saving,’ as opposed to investment.
“G” ( government spending ) is the sum of government expenditures on final goods
and services. It includes salaries of public servants, purchase of weapons for the
military, and any investment expenditure by a government. However, since GDP is a
measure of productivity, transfer payments made by the government are not counted
because these payment do not reflect a purchase by the government, rather a
movement of income. They are captured in “C” when the payments are spent.
“X” (exports) represents gross exports. GDP captures the amount a country produces,
including goods and services produced for other nations’ consumption, therefore
exports are added.
“M” (imports) represents gross imports. Imports are subtracted since imported goods
will be included in the terms “G”, “I”, or “C”, and must be deducted to avoid counting
foreign supply as domestic.
7.
The Consumption Function:
Many different factors, including tastes and preferences, income and interest rates,
determine consumption. For example, if the income of one household is greater than the
income of another, the former is likely to consume more.
Even if their incomes are the same, however, they will spend different amounts on
consumption if their attitudes toward thrift differ. Similarly, households vary their
consumption in response to changes in interest rates.
Although many factors affect consumption, aggregate income in the most important by far.
Consequently, we shall concentrate on the relationship between consumption and income,
called the consumption function.
The Saving Function:
Since the decision on how much income to consume implies a decision on how much to save,
a saving function may be derived with the aid of the consumption function.
8.
1. The Graphical Approach
By now, we are familiar with graphs of supply curves and demand curves. To find market equilibrium,
we combine the two curves onto one graph. The point of intersection of supply and demand marks the
point of equilibrium. Unless interfered with, the market will settle at this price and quantity. Why is
this? At this point of intersection, buyers and sellers agree on both price and quantity. For instance, in
the graph below, we see that at the equilibrium price p*, buyers want to buy exactly the same amount
that sellers want to sell.
The Algebraic Approach
We have worked with supply and demand equations separately, but they can also be
combined to find market equilibrium. We have already established that at equilibrium, there
is one price, and one quantity, on which both the buyers and the sellers agree. Graphically,
we see that as a single intersection of two curves. Mathematically, we will see it as the result
of setting the two equations equal in order to find equilibrium price and quantity
