What is Income Method? Meaning, Calculation, Examples

Income Method: The Income Method is a crucial approach to estimating national income by analyzing an economy's income components. This method calculates national income by considering the earnings received by factors of production, including rent, wages, interest, and profit. In this comprehensive guide, we will explore the meaning, calculation steps, included and excluded items, and examples of the income method.

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Income Method Meaning

The Income Method measures national income by summing up the factor incomes generated by all production units within a domestic economy over a specific accounting period. It is also known as the Factor Payment Method or the Distributive Share Method. The formula to derive National Income is:

National Income (NNPFC) = Domestic Income (NDPFC) + Net Factor Income from Abroad (NFIA)

Key Components of the Income Method

Wages and Salaries: Payments made to employees for their services.

Rent and Royalty: Earnings from land and intellectual property rights.

Interest: Income received from investments.

Profit: Earnings of businesses after deducting expenses.

Mixed Income: Self-employed and unorganized sector earnings.

Steps in Calculating National Income by Income Method

Below we've mentioned some steps for how to calculate income by income method:

Step 1: Identify Factor Incomes

Classify the production sectors into primary, secondary, and tertiary sectors. Identify their income sources.

Step 2: Calculate Factor Incomes

Factor incomes are categorized into:

Employee Compensation: Salaries, bonuses, and employer’s provident fund contributions.

Rent and Royalty: Income from leasing land, properties, or intellectual property.

Interest: Earnings from loans and investments.

Profits: Earnings from businesses after deducting operating costs.

Mixed Income: Income of self-employed individuals and freelancers.

Step 3: Compute Domestic Income (NDPFC)

The formula to calculate domestic income:

NDPFC = Employee Compensation + Rent & Royalty + Interest + Profit + Mixed Income

Step 4: Add Net Factor Income from Abroad (NFIA)

To calculate National Income (NNPFC):

NNPFC = NDPFC + NFIA

Treatment of Different Things in Income Method

Below we've mentioned treatment of different things in income method:

Included Things:

The following things are included in the calculation of national income:

• Imputed rent from owner-occupied properties.

• Employer’s contributions to provident funds and bonuses.

• Income earned by Indian workers abroad.

• Brokerage/commission on the sale of used goods.

• Capital formation, such as investment in infrastructure.

• Government spending on essential services, like health and education.

• Interest paid by commercial banks on deposits.

Excluded Things:

The following things are excluded from the calculation of national income by income method:

• Transfer payments like scholarships and pensions.

• Financial transactions (buying/selling stocks, bonds, etc.).

• Non-market activities such as household chores.

• Capital transfers like windfall gains (lottery, betting).

• Interest on government debt.

• Capital losses due to natural disasters.

• Resale of second-hand goods.

Income Method Examples

For the better umderstandings of the readers we've mentioned some examples:

Example 1:

Consider the following income components within the economy:

(i) Wages and Salaries: Rs. 7,200 crores

(ii) Corporate Profits: Rs. 3,500 crores

(iii) Income of Small Business Owners: Rs. 1,800 crores

(iv) Government Revenue from Domestic Production: Rs. 6,300 crores

National Income (NI) = Wages and Salaries + Corporate Profits + Income of Small Business Owners + Government Revenue from Domestic Production

= Rs. 7,200 crores + Rs. 3,500 crores + Rs. 1,800 crores + Rs. 6,300 crores

= Rs. 19,800 crores

In this case, the national income of the country, calculated using the income method, is Rs. 19,800 crores.

Example 2:

Consider the following income components within the economy:

(i) Employee Compensation: Rs. 8,900 crores

(ii) Operating Profits: Rs. 4,200 crores

(iii) Income of Freelancers and Artists: Rs. 2,700 crores

(iv) Government Earnings from Domestic Trade: Rs. 5,600 crores

National Income (NI) = Employee Compensation + Operating Profits + Income of Freelancers and Artists + Government Earnings from Domestic Trade

= Rs. 8,900 crores + Rs. 4,200 crores + Rs. 2,700 crores + Rs. 5,600 crores

= Rs. 21,400 crores

In this instance, the national income of the country, computed using the income method, amounts to Rs. 21,400 crores.

The Income Method is a vital approach to estimating national income as it reflects the total earnings of a country’s citizens. By accurately categorizing and summing up factor incomes, policymakers and economists can assess economic growth, development, and income distribution effectively. Understanding its components, exclusions, and applications helps in better economic analysis and planning.

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