National income (Y) is defined as the total level of output of the economy. There are 03 approaches for measuring national income and they are as follows:
Theoretically all 03 approaches should give the same figure as the national income but in practice they may differ due to various reason. Approaches to calculating national income can be explained as follows:
This is where the output of each sector is summed up to calculate the total output of the economy. In other words output of primary, secondary and tertiary sectors an economy is added up to calculate the GDP. Point to note here is that the “Added Value” of goods and services at each stage is accounted to avoid double counting.
As an example, Value of wheat is accounted at the manufacturing stage and when it is used in the production of bread the value of the bread is accounted excluded value of the wheat as the value of wheat was already accounted for at the manufacturing stage.
This is where the output of the economy is calculated based on the factor income received. In other words the payments/rewards for all factors of production are added up to calculate the output of the economy. The formula for National income (Y) based on income approach is
Y= Wages for labour + Rent on land + Interest on capital +Profits for entrepreneurship
This is the summation of the expenditure incurred by the economy. When calculating the national income under the expenditure approach following factors are taken into account.
There are 02 types of economies and depending on the type of the economy the formula for Y differs.
Three Sector Economy
This is where there are only households, business organizations and government exist. In other words, this type of economy can be called as a closed economy and there is no international trade present. For a three sector economy the formula for calculating national income is:
Y = C + I + G
Four Sector Economy
This is where there are households, business organizations, government exist with the addition of exports and imports due to the presence of international trade. This type of economy is called a open economy. For a four sector economy the formula for calculating national income is:
Y = C + I + G + (X-M)
National Income Equilibrium
This is where the injections to the economy is equal to the withdrawals from the economy. It can be represented in a formula as follows:
Total Injections = Total Withdrawals
Investments + Government Spending + Exports = Savings + Taxes + Imports
I + G + X = S + T + M