1. Three phases, three methods
- National income is generated in production, distributed as factor incomes and disposed of as spending. It can be measured at each phase.
- Product (value-added) method at production; income method at distribution; expenditure method at disposition.
- Because value added is paid out as incomes and incomes are spent on final output, the three totals are equal when measured correctly.
Key terms
- Value-added method
Measures national income as the sum of the values added by all producing units.
- Income method
Measures national income as the sum of factor incomes earned in production.
- Expenditure method
Measures national income as the sum of final expenditure on domestic output, adjusted to factor cost and national.
2. The value-added (product) method
- Value of output = sales + change in stock (closing stock − opening stock).
- Intermediate consumption: goods and services bought from other producers and used up in the year (raw materials, power, fuel, repairs). Machines and buildings are not intermediate consumption.
- Gross value added at market price = value of output − intermediate consumption.
- Net value added at factor cost = GVA at market price − depreciation − net indirect taxes (indirect taxes − subsidies).
- Sum of GVA of all units = GDP at market price; adjust to national income in the usual way.
| Term | Meaning | Formula |
|---|---|---|
| Value of output | Market value of all goods made by a firm in the year | Sales + change in stock |
| Change in stock | Closing stock − opening stock (can be negative) | Closing − opening |
| Intermediate consumption | Inputs bought from other producers and used up in the year | Raw materials, power, fuel, services |
| Gross value added at market price | What the firm adds to its inputs | Value of output − intermediate consumption |
| Net value added at factor cost | Value added paid out to factors | GVA at market price − depreciation − net indirect taxes |
| Step (imagined Pune pump maker, ₹ lakh) | Working | Result |
|---|---|---|
| Change in stock | 150 − 250 | −100 |
| Value of output | 2,400 − 100 | 2,300 |
| Intermediate consumption | 1,100 + 200 (machine of 300 left out) | 1,300 |
| GVA at market price | 2,300 − 1,300 | 1,000 |
| NVA at market price | 1,000 − 90 | 910 |
| NVA at factor cost | 910 − 60 | 850 |
| Unit (imagined Vidarbha chain, ₹ lakh) | Value of output | Intermediate consumption | Gross value added |
|---|---|---|---|
| Cotton farm | 400 + (0) = 400 | 60 | 340 |
| Ginning unit | 650 + (30) = 680 | 400 | 280 |
| Spinning mill | 1,000 + (-20) = 980 | 650 | 330 |
| Garment unit | 1,500 + (50) = 1,550 | 1,000 | 550 |
| Total | 3,610 | 1,500 |
Key terms
- Value of output
Sales plus the change in stock during the year.
- Intermediate consumption
Inputs bought from other producers and used up within the year.
- Value added
Value of output less intermediate consumption.
3. Double counting
- Double counting means counting the value of the same input more than once, which overstates output.
- It happens when the full sales of every firm in a chain are added.
- Two cures: (1) the final product approach, counting only final goods and services; (2) the value-added approach, counting only what each firm adds.
- Imagined Mandya chain: sum of sales ₹1,600 crore, but value of final output and total value added only ₹800 crore.
| Stage (imagined Mandya chain) | Sale (₹ crore) | Input bought (₹ crore) | Value added (₹ crore) |
|---|---|---|---|
| Cane grower sells cane | 300 | 0 | 300 |
| Jaggery unit sells jaggery | 500 | 300 | 200 |
| Sweet shop sells sweets to households | 800 | 500 | 300 |
| Total | 1600 (sum of sales) | 800 = value of final output |
Key terms
- Double counting
Counting the value of an input more than once in national output.
- Final good
A good bought for consumption or investment, not for resale or further production in the year.
4. The income method
- Compensation of employees: wages and salaries in cash and kind, and the employer's contributions to social security schemes.
- Operating surplus: rent and royalty, interest, and profit (corporation tax + dividends + undistributed profit).
- Mixed income of the self-employed: earnings that combine several factor rewards, such as those of farmers, artisans and small traders.
- Domestic income (NDP at factor cost) = compensation of employees + operating surplus + mixed income. National income = domestic income + net factor income from abroad.
- Steps: identify producing units and group them into sectors; classify and estimate their factor payments; add; adjust for factor income from abroad.
| Part of domestic income | What it contains | Example |
|---|---|---|
| Compensation of employees | Wages and salaries in cash and kind; employer's social security contributions | A nurse's salary and free housing |
| Operating surplus | Rent and royalty; interest; profit (corporation tax, dividends, undistributed profit) | Interest earned on a loan to a factory |
| Mixed income of the self-employed | Earnings that combine several factor rewards | A tailor working in her own shop |
| Included in compensation of employees | Not included |
|---|---|
| Wages and salaries in cash | Interest-free loans to staff (to be repaid) |
| Free meals, housing, uniforms (payments in kind) | Travel allowance for official tours (an input of the firm) |
| Employer's contribution to provident fund and health insurance | Pensions paid by the government (transfers) |
| Step (imagined Suvarnagiri, ₹ crore) | Working | Result |
|---|---|---|
| Compensation of employees | 1,450 + 140 | 1,590 |
| Profit | 90 + 230 + 200 | 520 |
| Operating surplus | 210 + 160 + 520 | 890 |
| Domestic income (NDP at factor cost) | 1,590 + 890 + 610 | 3,090 |
| National income | 3,090 + 25 | 3,115 |
| Left out | Interest on national debt 70; scholarships 40 | Transfers |
Key terms
- Compensation of employees
All rewards paid to employees for their work, in cash or kind, including employer social security contributions.
- Operating surplus
Income from property and entrepreneurship: rent, interest and profit.
- Mixed income
Income of the self-employed that cannot be split into separate factor rewards.
5. The expenditure method
- Final expenditure on domestic output: private final consumption expenditure; government final consumption expenditure; gross domestic capital formation (gross fixed capital formation + change in stock); net exports (exports − imports).
- Their sum is GDP at market price. National income = GDP at market price − consumption of fixed capital − net indirect taxes + net factor income from abroad.
- Imports are subtracted because they are produced outside the domestic territory.
- Steps: identify the units making final expenditure; classify it; estimate and add; adjust to national income.
| Component of final expenditure | Who spends | Example |
|---|---|---|
| Private final consumption expenditure | Households and non-profit bodies serving them | A family buys a refrigerator |
| Government final consumption expenditure | Government, for services it provides | Salaries of government teachers |
| Gross domestic capital formation | Producers | A new kiln; a rise in unsold stock |
| Net exports | Rest of the world (exports − imports) | Exports of tea less imports of oil |
| Step (imagined Tamrapatna, ₹ crore) | Working | Result |
|---|---|---|
| Gross domestic capital formation | 820 + (-40) | 780 |
| Net exports | 360 − 410 | -50 |
| GDP at market price | 3,200 + 650 + 780 + (-50) | 4,580 |
| GNP at market price | 4,580 + (-35) | 4,545 |
| NDP at factor cost | 4,580 − 180 − 260 | 4,140 |
| National income | 4,140 + (-35) | 4,105 |
| Item (imagined Shivgarh, ₹ crore) | Value | Treatment |
|---|---|---|
| Private final consumption | 960 | Add |
| Government final consumption | 240 | Add |
| Gross domestic capital formation | 300 | Add |
| Exports | 70 | Add |
| Imports | 90 | Subtract |
| Old-age pensions | 30 | Leave out: transfer |
| Purchase of shares | 55 | Leave out: financial asset |
| Second-hand buses | 25 | Leave out: counted when new |
| GDP at market price | 1,480 |
Key terms
- Private final consumption expenditure
Spending by households and non-profit institutions serving them on final goods and services.
- Gross domestic capital formation
Spending on new fixed assets plus the change in stock.
- Net exports
Exports minus imports of goods and services.
6. Precautions and difficulties
- Value-added method: avoid double counting; exclude sales of second-hand goods but include commissions on them; include production for self-consumption and imputed rent of owner-occupied houses.
- Income method: exclude transfer payments (pensions, scholarships, unemployment allowance, interest on national debt), windfall gains and capital gains; include payments in kind and imputed incomes; repayable loans to staff are not income.
- Expenditure method: count final expenditure only; exclude spending on second-hand goods, financial assets (shares, bonds) and transfer payments; include brokerage on financial assets.
- Unpaid services at home are left out by convention, though they are valuable.
- Difficulties in India: a large non-monetised sector; many small producers without accounts; under-reported informal incomes; difficulty of valuing depreciation and self-consumption; reliance on surveys and samples.
| Method | Measures at | Main items | Key precaution |
|---|---|---|---|
| Value added | Production | Value of output − intermediate consumption | Avoid double counting |
| Income | Distribution | Compensation of employees + operating surplus + mixed income | Leave out transfers |
| Expenditure | Disposition | Consumption + capital formation + net exports | Count final spending only |
| Value-added method: precaution | Why |
|---|---|
| Avoid double counting | Inputs are already inside the value of later output |
| Leave out sales of second-hand goods; count the commission | The good was counted when new; the dealer's service is new |
| Include production for self-consumption | It is output of the year even if not sold |
| Include imputed rent of owner-occupied houses | A housing service is produced and used |
| Income method: precaution | Why |
|---|---|
| Leave out transfer payments | No factor service is supplied in return |
| Leave out windfall gains such as lottery prizes | They are not earned in production |
| Leave out capital gains on selling old assets | No new output is produced |
| Include payments in kind and imputed incomes | They reward factor services |
| Expenditure method: precaution | Why |
|---|---|
| Count final expenditure only | Spending on intermediate goods is already in final goods |
| Leave out spending on second-hand goods | The goods were counted when first produced |
| Leave out purchases of shares and bonds | They are financial assets, not goods or services |
| Leave out transfer payments by government | The receivers' own spending is counted instead |
Key terms
- Transfer payment
A payment received without supplying any good or factor service in return.
- Imputed rent
The estimated rent of a house occupied by its owner, included in national income.
- Non-monetised sector
The part of the economy where output is used by producers themselves or bartered, not sold for money.
Exam tips
Common mistakes
- Starting from sales instead of value of output (sales + change in stock).
- Subtracting the purchase of a machine as intermediate consumption.
- Adding transfer payments, second-hand goods or shares.
- Forgetting the sign of a fall in stock, negative net exports or negative factor income from abroad.
- Leaving out imputed rent or production for self-consumption.
How marks are usually awarded
- Numericals: one mark for each correct intermediate aggregate and one for the final answer with its unit; a formula with the right items earns marks even after an arithmetic slip.
- Treatment questions: one mark per item for the decision with a reason.
- 4- and 8-mark questions in the ISC paper are set in parts; label each part.