What are the precautions taken while calculating National income by value added method and income method?

Precautions in Calculating National Income by Value Added and Income Methods

Calculating national income is a complex process, and accuracy is crucial for economic analysis and policy-making. Two common methods used are the Value Added Method and the Income Method. Each method requires specific precautions to ensure the accuracy and reliability of the national income estimation.

1. Precautions in the Value Added Method

The Value Added Method calculates national income by summing up the value added by each firm in the economy. Value added is the difference between the value of output and the value of intermediate goods used in production.

a. Avoiding Double Counting: The most critical precaution in this method is to avoid double counting. Only the value added at each stage of production should be included, not the total value of output at each stage.

b. Treatment of Depreciation: Proper accounting for depreciation or capital consumption is necessary. The value of depreciation should be subtracted from the gross value added to get the net value added.

c. Valuation of Inventories: Changes in inventories should be accurately valued. An increase in inventory is added to the value added, while a decrease is subtracted.

d. Exclusion of Intermediate Goods: It is crucial to exclude the value of intermediate goods used in production to avoid overstating the value added.

2. Precautions in the Income Method

The Income Method calculates national income by summing up all incomes earned by factors of production in the economy, including wages, interest, rent, and profits.

a. Inclusion of All Incomes: All factor incomes should be included. This includes not only wages and salaries but also self-employed income, interest, rent, and profits.

b. Treatment of Transfer Payments: Transfer payments like pensions, unemployment benefits, and subsidies should not be included as they are not payments for the production of goods or services.

c. Distinguishing Between Gross and Net Income: Gross income should be distinguished from net income. For an accurate measure of national income, indirect taxes are subtracted, and subsidies are added to the gross income.

d. Accounting for Undistributed Profits: Undistributed profits of companies should be included as they are part of the income generated by production.

e. Dealing with Illegal Income: Estimating and including illegal incomes poses a challenge. While they are part of national income, they are often not reported and are difficult to accurately estimate.

3. Common Precautions for Both Methods

Certain precautions are common to both methods:

a. Non-Market Transactions: Non-market transactions like household services are not included as they do not have a market transaction value.

b. Geographical Boundary: Only economic activities within the geographical boundaries of the country should be included.

c. Statistical Discrepancies: Efforts should be made to minimize statistical discrepancies due to data collection and estimation errors.

d. Time Period Consistency: The time period for measuring income should be consistent and typically is one fiscal or calendar year.

Conclusion

Accurately calculating national income is essential for understanding the economic health of a country. Both the Value Added Method and the Income Method require careful consideration to avoid errors such as double counting, improper treatment of depreciation, and exclusion of non-market transactions. By adhering to these precautions, a more accurate and reliable measure of a country’s economic performance can be obtained, which is crucial for effective economic planning and policy formulation.