Difficulties/Problems in the Measurement of National Income: According to Kuznets, the measurement of national income is a complicated problem and is best

with the following difficulties: (i) Non-availability of statistical material: Some persons like electricians, plumbers, etc., do some job in their spare time and receive income. The state finds it very difficult to know the exact amount received from such services. This income which, should have been added to the national income is not recorded due to {be lack of full information of statistics material. (ii) The danger of double counting: While computing the national income, there is always the danger of double or multiple counting. If care is not taken in estimating the income, the cost of the commodity is likely to be counted twice or thrice and national income will be overestimated. (iii) Non-marketed services: In estimating the national income, only those services are included for which the payment is made. The unpaid services, or non-marketed services are excluded from the national income. (iv) Difficulty in assessing the depreciation allowance: The deduction of depreciation allowances, accidental damages, repair, and replacement charges from the national income is not an easy task. It' requires high degree of judgment to assess the depreciation allowance and other charges. (v) Housing: A person lives in a rented house. He pays $5000 per month to the landlord. The income of the landlord is recorded in the national income. Let us suppose that the tenant purchases the same house from the landlord. Now the income of the owner occupant has increased by $5000. Is it not justifiable to include this income in the national income? Should or should not this income be recorded in the national income is still a controversial question. (vi) Transfer earnings: While measuring the national income, it should be seen that transfer payments should not become a part of national income. The payments made as relief allowance, pensions, etc. do not contribute towards current production. So they should be excluded from national income. (vii) Self-consumed production: In developing countries, a significant part of the output is not exchanged for money in the market. It is either consumed directly by producers or bartered for other goods This unorganized and nonmonetized sector makes calculation of national income difficult.

(viii) Price level changes: National income is measured in money terms. The measuring rod of-money itself does not remain stable. This means that national income can change without any change in output. Problems of Measurement is Under Developed Countries: The national income in under-developed countries like Pakistan, Afghanistan, etc., cannot be accurately measured due to the following reasons: (i) Self-consumed-bartered consumption: Some of the transactions of agricultural goods in the villages are done without the use of money. The statisticians, therefore, cannot measure the exact amount of the transactions for inclusion in the national income. (ii) No systematic accounts maintained: Most of the producers do not keep any record of the sale of the products in the market. This makes the task of national income still more complicated. (iii) No occupational classification: There is no occupational specialization in the under-developed countries. People receive income by working in various capacities. One person sometimes works as carpenter and at another time as mason. The statisticians cannot accurately measure the income of such persons. (iv) Unreliable data: The statisticians themselves do not feel the importance of figures which they collect They also do not take much pains for getting the reliable data. The figures of national Income are, therefore, not up-to-date in the under-developed countries. Methods of Computing/Measuring National Income: There are three methods of measuring national income of a country. They yield the same result. These methods are: (1) The Product Method. (2) The Income Method. (3) The Expenditure Method. We now look at each of the three methods in turn. (1) Product Method or Value Added Method:

Definition and Explanation: Goods and services are counted in gross domestic product (GDP) at their market values. The product approach defines a nation's gross product as that market value of goods and services currently produced within a nation during a one year period of time. The product approach measuring national income involves adding up the value of all the final goods and services produced in the country during the year. Here we focus on various sectors of the economy and add up all their production during the year. The main sectors whose production value is added up are: (i) agriculture (ii) manufacturing (iii) construction (iv) transport and communication (v) banking (vi) administration and defense and (vii) distribution of income. Precautions For Product Method or Value Added Method: There are certain precautions which are to be taken to avoid miscalculation of national income using this method. These in brief are: (i) Problem of double counting: When we add up the value of output of various sectors, we should be careful to avoid double counting. This pitfall can be avoided by either counting (he final value of the output or by including the extra value that each firm adds to an item. (ii) Value addition in particular year: While calculating national income, the values of goods added in the particular year in question are added up. The values which had previously been added to the stocks of raw material and goods have to be ignored. GDP thus includes only those goods, and services that are newly produced within the current period. (iii) Stock appreciation: Stock appreciation, if any, must be deducted from value added. This is necessary as there is no real increase in output. {iv) Production for self consumption: The production of goods for self consumption should be counted while measuring national income. In this method, the production of goods for self consumption should be valued at the prevailing market prices. (2) Expenditure Method:

Definition and Explanation: The expenditure approach measures national income as total spending on final goods and services produced within nation during an year. The expenditure approach to measuring national income is to add up all expenditures made for final goods and services at current market prices by households, firms and government during a year. Total aggregate final expenditure on final output thus is the sum of four broad categories of expenditures: (i) consumption (ii) investment (iii) government and (iv) Net export. (i) Consumption expenditure (C): Consumption expenditure is the largest component of national income. It includes expenditure on all goods and services produced and sold to the final consumer during the year. (ii) Investment expenditure (I): Investment is the use of today's resources to expand tomorrow's production or consumption. Investment expenditure is expenditure incurred on by business firms on (a) new plants, (b) adding to the stock of inventories and (c) on newly constructed houses. (iii) Government expenditure (G): It is the second largest component of national income. It includes all government expenditure on currently produced goods and services but excludes transfer payments while computing national income. (iv) Net exports (X - M): Net exports are defined as total exports minus total imports. National income calculated from the expenditure side is the sum of final consumption expenditure, expenditure by business on plants, government spending and net exports. NI = C + I +G + (X - M) Precautions Precautions For Expenditure Method: While estimating national income through expenditure method, the following precautions should be taken: (i) The expenditure on second hand goods should not be included as they do not contribute to the current year's production of goods.

(ii) Similarly, expenditure on purchase of old shares and bonds is not included as these also do not represent expenditure on currently produced goods and services. (iii) Expenditure on transfer payments by government such as unemployment benefit, old age pensions, interest on public debt should also not be included because no productive service is rendered in exchange by recipients of these payments. (3) Income Approach: Income approach is another alternative way of computing national income, This method seeks to measure national income at the phase of distribution. In the production process of an economy, the factors of production are engaged by the enterprises. They are paid money incomes for their participation in the production. The payments received by the factors and paid by the enterprises are wages, rent, interest and profit. National income thus may be defined as the sum of wages, rent, interest and profit received or occurred to the factors of production in lieu of their services in the production of goods. Briefly, national income is the sum of all income, wages, rents, interest and profit paid to the four factors of production. The four categories of payments are briefly described below: (i) Wages: It is the largest component of national income. It consists of wages and salaries along with fringe benefits and unemployment insurance. (ii) Rents: Rents are the income from properly received by households.

(iii) Interest: Interest is the income private businesses pay to households who have lent the business money. (iv) Profits: Profits are normally divided into two categories (a) profits of incorporated businesses and (b) profits of unincorporated businesses (sold proprietorship, partnerships and producers cooperatives). Precautions For Income Approach: While estimating national income through income method, the following precautions should be undertaken. (i) Transfer payments such as gifts, donations, scholarships, indirect taxes should not be included in the estimation of national income.

(ii) Illegal money earned through smuggling and gambling should not be included. {iii) Windfall gains such as prizes won, lotteries etc. is not be included in the estimation of national income. (iv) Receipts from the sale of financial assets such as shares, bonds should not be included in measuring national income as they are not related to generation of income in the current year production of goods. Why Three Methods of Computing/Measuring National Income are Equal: The three approaches used for measuring national income give the same result. The reason is the market value of goods and services produced in a given period by definition is equal to the amount that buyers must spend to purchase them. So the product approach which measures market value of good and services produced and the expenditure approach which measures spending should give the same measure of economic activity. Now as regards the income approach, the sellers receipts must equal what the buyers spend. The sellers receipts in turn equal the total income generated by the economic activity. Thus, total expenditure must equal total income generated implying that the expenditure and income approach must also produce the same result. Determination of National Income 1. In the short run, the level of national income is determined by aggregate demand and aggregate supply. The supply of goods and services in a country depends on the production capacity of the community. But during the short period the productive capacity does not change. 2. If AD increases, output will also increase and the level of national output (i.e., national income) will rise. On the other hand, if AD decreases, the national output or national income will also decrease. It follows that the equilibrium level of NI is determined by AD since the aggregate capacity remains more or less the same during the short run. 3. Thus, there are two components of effective demand: (a) Consumption demand, and

(b) Investment demand. 4. Aggregate Demand i.e., AD = = C Consumption + I + Investment

5. The consumption demand depends on propensity to consume and income. At a given propensity to consume, as income increases, the consumption demand will also increase.

6. In the above diagram the 45o line represents aggregate supply line and it is also called income line. This income line shows two things: (a) Total output or aggregate supply (C + I), and (b) National income. 7. In the above diagram, the curve C rises upward to the right which means that as income increases consumption also increases. The distance between income line and consumption line represents saving. Thus, NI = C + S or Y = C + S. 8. One noteworthy thing about propensity to consume is that it remains stable or constant during the short period. Because the propensity to consume depends on the tastes and needs of the people and these do not change in the short run. 9. Since consumption is more or less stable and cannot be varied, therefore, variation in NI depends on variation in investment.

10.Investment is the second component of AD. Investment depends on two things: (a) Marginal efficiency of capital, and (b) The rate of interest 11.The rate of interest is more or less stable, hence, change in investment depends on the marginal efficiency of capital (MEC). 12.The MEC means expectations of profit from investment. In other words, the expected rate of profit is called MEC. 13.The MEC depends on two factors: (a) Replacement cost of capital goods, and (b) Profit expectations of investors. 14.If we join the investment demand with the curve C of propensity to consume, we get AD curve C + I in which C represents consumption and I investment. The distance between propensity to consume curve C and AD curve C + I is equal to investment. 15.The level of NI will be determined at point at which the AD and AS curves intersect each other. At this point AD and AS are in equilibrium. 16.In the above diagram, the equilibrium level of income is OY. At this point the AD curve and AS curve intersect each other. 17.If the income is more than OY, than total output or AS is greater than AD (C + I), and the entire output cannot be sold out. 18.If the income is less than OY, then total output or AS is less than AD (C + I), and the entire output will be sold out. In such a situation there is a shortage of supply, but the output will be increased in order to cover the shortage and the NI will also increase. 19.OY is the equilibrium level of income which is less than full employment level, i.e., OYF. Whereas, the HF corresponds the saving. 20.The economy will be in full employment level only when investment demand increases so as to cover this saving. But there is no guarantee that investment demand will exactly be equal to savings. Equality of Saving and Investment:

1. There is another way of determining the equilibrium level of NI, i.e., through equality of savings and investment. 2. Take the same diagram of AD and AS. At point E, the savings and investment are equal to GE. At above the point the saving is more than investment, and for income less than this point, the investment is more than saving. Saving and investment are only equal at the equilibrium level of income, and when they are not equal, the NI is not in equilibrium. 3. When at a certain level of NI intended investment by the entrepreneurs is more than intended savings by the people, this would mean that AD is greater than total output or AS, i.e., I > S or AD > AS This would induce the firms to increase production raising the level of income and employment. 4. Hence, when at any level of NI, investment is greater than savings, there will be a tendency for the NI to increase. 5. On contrary, when at any level of NI, the investment demand is less than saving, it means that AD is less than AS. As a result of a decline in national output, the national income will also reduce. 6. Saving is withdrawal of some money from the income stream. On the other hand, investment is the injection of money into the income stream. If the intended investment is more than intended saving, it means that more money has been injected in the economy. This would increase the national income. 7. But when investment is just equal to saving, it would mean that as much money has been put into income stream as has been taken out of it. The result would be that the NI will neither increase nor decrease, i.e., it would be in equilibrium. The determination of NI by investment and saving is illustrated in the following diagram:

8. In the above diagram, the investment line (II curve) has been drawn parallel to the X-axis. This is done on the assumption that in any year, the entrepreneurs intend to invest a certain amount of money. That is, we assume that investment does not change with income. 9. The saving line (SS curve) shows intended saving at different levels of income. 10.The saving line and investment line intersect each other at the equilibrium point E, where the intended saving and the intended investment are equal at OY level of income. Hence OY is the equilibrium level of NI. 11.In the above diagram, there is no tendency for income to increase or decrease. 12.If the income level is greater than OY, the amount of intended investment is less than saving, as a result, the income will finally decrease. 13.If the income level is less than OY, the amount of intended investment is greater than intended saving, as a result, the income will continue to increase to the equilibrium level. Inflationary Gap: Inflationary gap arises when consumption and investment spending together are greater than the full employment GNP level. This means that people are demanding more goods and services than can be produced. In other words, the implication of inflationary gap is that national income, output and employment cannot rise further. The only consequence of increased demand is that the price level will increase. Or we may say that there will be an inflationary gap if scheduled investment tends to be greater than full employment saving. In a

situation like this, more goods will be demanded than the economic system can produce. The result will be that price will begin to rise and an inflationary situation will emerge. Thus, if full employment saving falls short of scheduled investment at full employment (which means that peoples propensity to spend is higher than the propensity to save), there will be an inflationary gap.

In the above diagram, C + I + G (consumption, investment and government spending) line shows the total expenditure on demand in the economy. At this level, Y is the real output, as shown by the intersection, point D, with the 45o line. YF represents a full employment level on real output. Real income of the economy, obviously cannot reach Y. At YF, total demand (C + I + G) exceeds total output, leaving a gap AB, which is the inflationary gap in the Keynesian sense. Deflationary Gap: The deflationary or recessionary gap is the amount by which the aggregate expenditure falls short of the full employment level of national income. It causes a multiple decline in real NI.

In the above diagram, Y is the total output at full employment level. Let us assume that the total demand is (C + I + G) which cuts the 45 o line at B, with real output Y, AB then is the deflationary gap. The Definition of MPC & MPS in Economics

Suppose you receive a pay raise at work. Chances are, you will spend some of the additional money you earn, buying things you could not afford previously. You also may save some of the additional for the future. Economists have mathematical measures for studying how changes in income change a person's consumption and saving habits. They call them the "marginal propensity to consume" and "marginal propensity to save." Related Searches:

1. MPC Definition
o

The marginal propensity to consume (MPC) is the proportion of additional income that a person uses for consumption. Economists calculate the MPC by dividing the change in consumption by the change in income. For example, if a person receives $100 in additional income and spends $70 of it in additional consumer spending, then the MPC equals 0.70.

MPS Definition
o

The marginal propensity to save (MPS) is the flipside of the MPC and is the proportion of additional income that a person dedicates to saving. To calculate the MPS, divide the change in saving by the change in income. If the same person in the earlier example receives $100 of additional income and saves $30 of it, then the MPS equals 0.30.

Theory
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The MPC and MPS measures in economics have their roots in the work of early 20th century economist John Maynard Keynes, who contended that a psychological law of consumer behavior separated his economic theories from the classical perspectives of his time. This psychological law, according to Keynes, held that people have the propensity to spend most, but not all, of the additional income they receive.

Effects
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Changes in consumption and saving, as measured by the MPC and MPS, ripple throughout the economy, laying the foundation for what economists call the "multiplier": the interaction between consumption and production that leads to changes in aggregate economic output, or gross domestic product. With a larger MPC, consumption is higher, generating more income for producers, who increase production. The additional production raises incomes, fueling even more consumption and saving.