Circular Flow of Income and Measurement of National Income in India
Circular Flow of Income in Different Sectors
Household Sector
Households provide factor services to firms, the government, and the foreign sector. In return, they receive factor payments. Households also receive transfer payments from the government and the foreign sector. Households spend their income on:
- Payment for goods and services purchased from firms
- Tax payments to the government
- Payments for imports
Firms
Firms receive revenue from households, the government, and the foreign sector for the sale of their goods and services. Firms also receive subsidies from the government. Firms make payments for:
- Factor services to households
- Taxes to the government
- Imports to the foreign sector
Government
The government receives revenues from firms, households, and foreign countries for the sale of goods and services, taxes, etc. The government makes factor payments to households and also spends money on transfer payments and subsidies.
Foreign Sector
The foreign sector receives revenue from firms, households, and the government for the export of goods and services. It makes payments for:
- Import of goods and services from firms and the government
- Factor services to households
Measurement of National Income
National income can be measured by three methods:
- Output or Production Method
- Income Method
- Expenditure Method
Output Method or Production Method
This method approaches national income from the output side. This method is also called the value-added method. Under this method, the economy is divided into different sectors such as agriculture, fishing, mining, construction, manufacturing, trade and commerce, transport, communication, and other services. National income is the combined value of the new and final output produced in all sectors of the economy.
Income Method
This method approaches national income from the distribution side. According to this method, national income is obtained by summing up the incomes of all individuals in the country. Thus, national income is calculated by adding up the rent of land, wages and salaries of employees, interest on capital, profits of entrepreneurs, and income of self-employed people.
Expenditure Method
This method arrives at national income by adding up all the expenditures made on goods and services during a year. Thus, the national income is found by adding up the following types of expenditure by households, private business enterprises, and the government.
GDP = C + I + G + (X – M)
- C: Expenditure on consumer goods and services by individuals and households
- I: Expenditure by private business enterprises on capital goods and services on making additions to inventories
- G: Government expenditure on goods and services, i.e., government purchases
- (X – M): Expenditure made by foreigners on goods and services of the national economy (Exports – Imports)
Difficulties in Measuring National Income in India
Following are some of the notable difficulties in measuring NI in India:
Non-Monetized Sector
In India, the bulk of goods and services produced do not come to the market for sale. These are either consumed by the producers themselves or exchanged through a barter system, where goods and services are exchanged without the use of money.
Lack of Distinct Differentiation
A large number of workers are engaged in many activities simultaneously. For example, many small farmers in India are also engaged in cottage and small industries.
Black Money
Black money is defined as money generated from activities that are kept secret and are not reported to the fiscal authorities, meaning taxes are not paid on this money. To evade income tax, income from different sources is under-reported, leading to inaccurate estimates of NI.
Non-Availability of Data About Certain Incomes
Data about the income of small producers and household enterprises is not readily available. Similarly, there is no correct estimation of value added from agriculture, horticulture, etc. It is made only on the basis of guesswork.
Fluctuation in Price Level
When prices are rising, the NI figures are rising even though production might have gone down. On the other hand, when prices are falling, the NI figures are falling, even though production might have gone up.
Inflation
In economics, inflation is a rise in the general level of prices of goods and services in an economy over a period of time.
- Inflation is a process of rising prices.
- Money buys less when the price level rises.
- The value of money varies inversely with the price level.
Prof. Coulborn has defined inflation as “too much money chasing too few goods”.
Inflation is an increase in the price to pay for goods. It is the general increase in prices and fall in the purchasing value of money. It means your money cannot buy as much as it would and makes it difficult for consumers to afford even the basic commodities in life, e.g., food, housing, gas, automobiles, etc.
Inflation is monitored by the government, usually yearly.
Features of Inflation
- It is a process of rising prices.
- It is initiated by some changes which make it impossible to meet the whole of the demand at the existing prices.
- It is propagated by the reaction of the buyers.