Product Method of National Income
Product method is also known as output method or value added method. In this method, we calculate the national income in terms of final goods and services produced in an economy during a particular period of time. The final goods are those which are either available to the consumers for consumption or become a part of national wealth in the form of investment.
Definition
Product method is that which estimates the national income by measuring the contribution of final output and services by each producing enterprise in the domestic territory of a country during a given accounting period.
Steps in Product Method
Classification of Productive Enterprises
The first step in this method of measuring national income is the classification of enterprises. All the productive enterprises in the economy are classified into three main categories, viz. (i) Primary Sector, (ii) Secondary Sector and (iii) Tertiary Sector. Let us briefly explain these sectors.
(i) Primary Sector – Primary sector refers to that sector of the economy which exploits natural resources to produce goods. Agriculture and allied activities like mining, quarrying, fishing, forestry etc. are included in this sector.
(ii) Secondary Sector – The manufacturing sector of the economy which transforms one physical good into another is included in the secondary sector.
(iii) Tertiary Sector – Primary sector refers to that sector of the economy is known as the tertiary sector. This includes banking, insurance, education, trade, commerce etc.
Step II.
Classification of Output
National output is classified into the following types:
(i) Consumer Goods – Consumer goods are those goods which help in the further production of consumer gods. These are also called are also called capital goods.
(ii) Producer Goods– Producer gods are those goods which help in the further production of consumer gods. These are also called capital gods.
(iii) Govt. Produced Goods– These include defence, police, education, health care, roads, railways, ports, dams etc.
(iv) Net Exports– Net exports refer to the value of goods and services exported to the rest of the world minus the value of goods & services imported during an accounting year.
Step III.
Measurement of Value of Output
There are two methods of measuring the value of output. They are (i) Final output method, (ii) Value added method. Below we discuss these two approaches of product method of measuring national income.
(i) Final Output Method
In final method, we have to estimate the following element involved to arrive at the correct figure of the final output.
(a) Value of output
Here output means final goods as well as intermediate goods. The value of all these goods can be estimated by multiplying the quantity of output of each producing unit with the market price. This is equal to the value of sales and the change in stock.
(b) Value of intermediate consumption
The goods and services used by the firms as inputs are known as intermediate consumption. To calculate the value of intermediate consumption, we have to multiply the intermediate goods with the prices paid by the enterprises to purchase these goods.
(C) Consumption of fixed capital
Consumption of fixed capital means depreciation. When goods are produced, there is wear and tear of machines leading to the loss of value of the capital assets. To calculate this loss of value in an accounting period, we have to deduct the value of capital asset at the end of the period from the value of the asset at the beginning of the period.
According to final output method, the value of intermediate goods is deducted from the value of output. The quantity produced by each producing enterprise is multiplied by the market price. This gives us the value of output. From this, we deduct the value of intermediate consumption to arrive at the value of the output.
Value of final output= Value of output- Value of intermediate goods
When we add the market value of final output in the primary sector, secondary sector and that of tertiary sector, we arrive at gross domestic product at market price.
GDP at Market Price = Market value of final output of primary sector + Market value of final output of tertiary sector
By deducting depreciation from GDP at market price we can get net domestic product at market price. When we add net factor income from abroad, we get GNP and NNP at market price.
Net Domestic Product at Market Price = Gross Domestic Product at Market Price-Depreciation
(ii) Value Added Method:
Value added refers to the addition of value of intermediate goods in the process of production. To estimate the national income through value added approach, we have to add the value added in each producing enterprise within the domestic territory of a country.
Definition
Value added method is that method which measures the contribution of each producing enterprise to production in the domestic territory of the country.
Step Involved in the Method
Step 1. Identification and Classification of Enterprises
The first step involved in this method is to identify and classify the productive enterprises. As said earlier we can classify these enterprises into three broad categories, viz. (a) Primary Sector, (b) Secondary Sector, (c) Tertiary Sector.
Step II. Estimation
The second step involved is the estimation of value added. For this purpose we have to calculate the value of output and value of intermediate consumption. This method is adopted to avoid the problem of double counting. In order to estimate the value added by a productive enterprise, the value of intermediate good is deducted from the value of total output of the productive enterprise.
Value Added = Value of Output – Value of Intermediate Goods
Step III
The third step in the estimation of national income is to add up the gross value added by all the producing units across three sectors of the economy. This gives us the gross domestic product at market price. To obtain the net value added, the value of depreciation has to be deducted from the gross value added at market price. Thus we can arrive at the net domestic product at market price.
To calculate the net national income, we have to add up the net factor income from abroad with the net domestic product.
Precautions to be Taken
- The transactions of second hand goods are not to be included.
- Commission earned in the transaction of second hand goods by the commission agents is included in the estimation of value added.
- Value of intermediate goods like raw materials, semi finished goods is not to be included.
- Illegal activities like smuggling, gambling etc. are excluded in the calculation of value added.
- Service of housewives are excluded.
- Imputed value of the product kept for self-consumption should be taken into account.
- Imputed rent of owner-occupied dwellings has to be included.
