Saturday, February 28, 2015

National Income - Part I

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National Income is the total value of all the new goods and services produced as final output of a country in a year.

First try to understand how a product is manufactured and sold.

Typically, goods are produced in several stages. At one stage, raw materials are converted by firms, and then sold to another firms for next stage. Value is added at each intermediate stages. At the final stage, a retail selling price is tagged with the final product. Note that the retail price reflects the value added in terms of all the resources used in all the previous stages of production.

Final goods
To avoid the problem of double counting, only the value at the final stage, i.e., the retail price of the final good is included (not the value added in all the intermediate stages - the cost of production and profit)

Therefore, while considering National Income, the value of all the final goods (and services) produced in a year in a country is calculated.

For example, suppose a car has a retail price of Rs. 5 lakh. This retail price includes Rs. 2.5 lakh for componentsRs. 50,000 for assembly of components, and Rs. 1 lakh for marketing purpose, and also a Profit of Rs. 1 lakh.
To avoid double-counting, the national income accounts only the value at the final stage (in this case Rs. 5 lakh, i.e, the selling price of the car)

Methods of calculating National Income
Consider the following example first -
Suppose, you bought a book worth Rs. 100. It means, your expenditure is Rs. 100income of the bookseller is Rs. 100, and the value of the book is Rs. 100.
Therefore, the transaction involves elements -

  • Expenditure by purchaser
  • Income of seller
  • Value of goods
All of the transactions can be looked at in the same way, making 3 methods of calculating National Income -

  1. Production Method - This method is based on the total production of a country during a year. The combined value of the new and final output produced in all sectors of the economy (including foreign income of production) is considered to determine the national income.
  2. Income Method - This method adds all incomes received by the factors of production generated in the economy during a year. It includes wages from employment, profits to firms, interests to lenders, rents to landlords, and income from abroad.
  3. Expenditure Method - This method adds all spending in the economy by households and firms on final goods and services and spending by government.

to be continued..

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