INCOME METHOD OF MEASUREMENT OF NATIONAL INCOME
‘The sum of rent, salary, interest and profit gives the lion share of the income -calculated GNP’
The income method is in line with the definition of national income as “the sum of all incomes earned by all factors of production in a country in a given period”. Thus the sum of all factor incomes gives the national income estimate or the Gross National Income (GNI).
The income method therefore adopts the “factor income approach”. It involves adding up all incomes earned by all agents or factors of production of a country in a given period. And for clarity purpose, we wish to indicate the rewards of the major factors of production as follow:
Table above shows rewards of factors of production
From the above, land earns rent, labour receives salary, capital yields interest and Entrepreneur (a firm’s owner) realizes profit. And the sum of rent, interest, salaries and profit gives the lion share of the GNI. For thesake of thorough discussion of the national income accounting purposes, we wish to discuss each of them in detail as follow:
It is payment made for the use of land and (permanent) structure thereupon, like dwelling houses, public buildings, open spaces on the earth’s surface, farmlands, as well as exploitation of natural resources (royalties). Rent is therefore classified as follows:-
- Rent paid by tenants – rent from tenant-occupied houses.
- Estimated rent of owner-occupied houses.
- Payment made for the use of farmlands, open spaces (like playing ground, car park, etc).
- Royalties- payment made by mining firms for exploiting natural resources, especially minerals.
The sum of the above gives the total rent accruing to individuals and government(s) of a country in a given period.
Wages refer to amount of money paid to casual workers; those who work on temporary (daily or weekly) basis. While salaries are amount of money paid to permanent workers – staff of a company or an institution. Both wages and salaries are termed as incomes from direct employment and they are included in the national income.
Also incomes from self-employed individuals, e.g. barbers, tailors, welders, repairers, palm fruit collectors, . fishermen, farmers, professionals, artisans, etc, are also estimated and included in the national income. Thirdly, all fringe benefits, either in cash or kind like Christmas bonus, all allowances, employers’ contribution to pension fund, etc, should be assessed (determined) and added to the national income.
It is payment made for the use of capital – income realized from amount of money lent out to borrowers. It takes the form of interest charged on loans as well as dividends reralised from purchases of securities, e.g. shares, stocks, bills, bonds, debentures, etc. Also physical assets like machines, vessels, vehicles, aircrafts, etc, given out for use earn incomes. Such incomes realized from leasing of above equipment are included in the national income.
Profit is the amount by which total revenue exceeds total cost. It is a reward accruing to entrepreneurs (firms’ owners). Profits of firms, both distributed profit (dividends) and undistributed profit (reserved profit), are included in the national income. Also profits of proprietors, workshop owners, carpenters, individual traders or small retailers are estimated and included in the national income. These incomes are given in a tabular form below.
Note: The components (major parts) of national income at factor cost are: rent, salary, interest and profit.
Incomes generated by factors of production
Table above shows detailed compensations of factors of production.
The sum of rent, salaries, interest, profits, incomes of self-employed individuals plus net income from abroad minus stock appreciation gives Gross National income (GNI). And deduction of depreciation gives Net National Income (NNI).
Subtraction and Addition
In order to show the true picture of the actual earnings of all the people of a particular country, certain amount ought to be deducted and others added. The major ones are as follow:-
1) Transfer payment: Income received without work, they are payments made by a person, a group of persons – a firm or a government to other people not on account of involvement in the current production of goods and services but as a form of assistance (gift) or aid. Hence they are referred to as ‘value received and not value created’. Transfer payments are not added to the national income. The following are good examples of transfer payment:-
- Pension payment.
- Students’ grants and scholarship.
- Social security (unemployment benefit).
- Payment of interest on public debts.
- Payment to aged parents.
- Disability payments (payments to disabled, orphanages and beggars).
- Payment to refugees (flood/war victims).
- Other welfare payments.
2) Inventory appreciation
Inventory refers to unsold stock of goods in the warehouse or store at the end of an accounting period. In production firms (factories), they also include work-in-progress or unfinished goods – items that have not been completely manufactured. The value of these items may appreciate (rise) in the next period due to inflation. And any rise in monetary value of goods as a result of increase in prices is always deflated (deducted) to obtain their true value.
Inventory appreciation or stock appreciation is unnecessary rise in value of unsold goods due to rise in prices. Thus inventory appreciation, if any, is always deducted from the GDP.
4) Net property income from abroad.
5) Fringe benefits
All fringe benefits, either in cash or in kind, like Christmas bonus, allowances, employers’ contribution to pension fund (NPF), etc, should be estimated and included in the National Income.
Summary of items to be either added or subtracted under income method.
You should note that we do not subtract ‘transfer payments’ as they are not regarded as factor payments or income generated. Thus they are not included in the national income.
Imaginary figures of national income through the income approach.
- GDP = Salary + rent + interest + profit + self-employed income minus stock appreciation.
- GNP = Sum of all factor incomes minus stock appreciation plus NPYA.
Review of income method
The income method adopts the factor income approach. It involves calculation of incomes accruing to (received by) all factors of production in a country in a given period. The factor incomes are: rent. Salaries/wages, interest, and profit; and their sum gives the lion share of the Gross National Income (GNI).
Also we have to calculate the incomes of self employed individuals, like those of agricultural sectors, e.g. farmers, fishermen, as well as artisans and professionals. They should be added to the national income estimate. All workers’ fringe benefits should be assessed and added. Also we have to determine the net property income from abroad. It is added if positive and subtracted if negative.
It is important to note that all types of transfer payments shouldn’t be included in the national income as they are incomes received without being involved in any form of work. Also stock appreciation should be ascertained (known) and it should be deducted from GNI. Depreciation value of fixed capital goods should be known and the amount should be deducted from the GNI to obtain the Net National income (NNI) at factor cost.
The problems peculiar to the income method are: inadequate record, high rate of illiteracy, undisclosed interest and profit as well as inaccurate foreign record. They cause inaccurate estimate and make the calculation to be based on sheer guesses.
The income method calculates all incomes earned (received) by all factors of production in a country in a year. They are salary/wages for labour, rent for land, interest for capital and profit for entrepreneur. It also measures incomes of self employed individuals like farmers, artisans, professionals, etc. In order to avoid double counting, it does not include transfer payment like incomes of beggars, pensioners, etc. Addition of net income from abroad gives us the GNI at factor cost.
Formula for calculating NY through the income method
GDI = A + B + C + D +E
GNI = A + B + C+ D+E+ F
NNI = (A to F) – G
A – G represents the following
A = Rent.
B = Salary/Wages.
C = Profit.
D = Interest.
E = Incomes of Self employed.
F = Net income from abroad.
G = Capital consumption (depreciation).
H = Taxes.
I = Subsidies.
J = Transfer payment.
Calculate the N. Y through income method with the following data .
A = 40, B =70, C = 150, D = 50, E = 80, F = 10 and G = 15, H = 30, 1 = 35, J = 25
GDI (incomes generated within the country) = 40 + 70 + 150 + 50 + 80 + 35 — 30 = N295
GNI (income generated both within and outside the country) = 295 + 10 = N305
NNY = 305 – 15 = N290
Profit = dividends plus undistributed profit
Dividends are also referred to as distributed profit, while undistributed profit is also called reserved or retained profit Dividend is a part of profit distributed (sent) to shareholders. It is their share in the profit.