Difficulties in calculation of national income

Measurement of national income is of great importance, because it is a dependable index of prosperity and welfare of the country. However, measurement involves certain difficulties which have to be overcome so as to make national income estimates as accurate and representative as possible. In developing countries, difficulties in measurement of national income are prominently experienced. They may be discussed as follows-

I] Theoretical difficulties

Theoretical difficulties are also known as conceptual difficulties.

1] Transfer payments

According to some it is difficult to calculate the amount of transfer expenditure incurred on various schemes, such as, old age pension, unemployment allowance, gifts etc.

On one hand these earnings are a part of individual income, and on the other hand they are government expenditure. [However, this difficulty does not appear to be very serious. The state generally maintains proper accounts of such expenditure and ordinarily, there should be no difficulty in computing such expenditure].

Since these payments do not add to the economic/productive activities of the nation they are ignored while calculating national income.

2] Income of foreign [multinational] firms and persons working in foreign countries

a) There is also a problem regarding the income of multinationals or foreign concerns and people operating in a country. The problem is whether their income should be included in the country where they operate or in the county of their origin.

According to the IMF view-point, income of a foreign firm should be included in the national income of the country, where the firm actually undertakes production work.

However, profits earned by foreign firms are credited to the parent concern.

b) Difficulties arising because of external debt In case of such debts, payments have to be made on account of interest charges to the foreigners. To this extent national income declines. Therefore such payments and also receipts have to be properly maintained

c) There are also difficulties in calculating the volume of national income due to international trade. It is necessary to deduct from the domestic expenditure the values of goods and services imported and to add the value of goods and services exported to other countries. In other words the net difference between the value of imports and the value of exports should be properly adjusted.

3] Unpaid services

[Difficulty in computing national income because of self services]

Generally, national income is calculated in respect of goods and services which are exchanged for money, but there are a number of goods and services which are difficult to be assessed in terms of money. For example,

a) painting as a hobby; services which are rendered by a person to self, such as shaving, washing of clothes, maintain the gardens, services of housewives,

b) services provided out of love, affection, mercy, sympathy and charity etc.

The value of such services is not taken into consideration while calculating national income as remuneration is not given to them as it is difficult to keep a track of these activities and include them in national income.

If such services are received from other persons on payment of money, they are taken into consideration while calculating national income.

Therefore, to that extent, there is under estimation of national income. Therefore national income will be inaccurate and unreliable.

4] Income [money generated] from illegal activities

Income received through illegal activities, such as gambling, black marketing, theft, smuggling etc.

Such goods and services do have value and they do meet the needs of the consumers, but they do not contribute to the economic activity in the nation. Therefore income derived from such activities is not reflected in the total national income and to that extent there is a underestimation of the volume of national income.

5] Treatment of the government sector [expenditure incurred on state activities]

The state which performs various functions and activities has to incur a huge expenditure. The question is how this expenditure should be treated. Generally expenditure incurred on a number of public services like, defence, public administration, maintenance of law and order etc. Estimating the market value of such government services is difficult, as the real value of these services is not known. Therefore they are treated as final consumption expenditure and included in calculation of national income.

6] Production for self consumption [or difficulty on account of goods used for self consumption]

In several cases, certain goods produced by people are used for self consumption. For example

a) Farmers use some of the goods eg food grains, milk, vegetables fruits and other farm products for their own consumption. These goods do not enter the market. The value of such goods are estimated at their market price and included in national income as they contribute to the current year’s productive/economic activity.

b) It is also difficult to calculate the rental value of self occupied premises. Many individuals reside in their own houses and in such cases, it not easy to calculate the income which would accrue to its owner.

c) Same difficulty arises in case of public buildings.

7] Changing price levels and value of money

a) When the price level in the country rises, national income also shows an increase irrespective of the amount produced and when the price level in the country falls, national income also shows a decrease irrespective of the amount produced. This is because national income is calculated in terms of money, at market price. Therefore there may be over estimation or under estimation of national income respectively.

b)National income is calculated in terms of money. But the value of money is not stable, as it changes from time to time, due to which the estimates of national income are affected and consequently, it is not possible to have an accurate picture of the national income.




II] Practical difficulties

Practical difficulties are also known as statistical difficulties

1] Problem/possibility of double counting

a) One of the greatest difficulties in calculation of national income is of double counting. It arises from failure to distinguish properly, between a final and an intermediate product.

For example, flour used in a bakery is an intermediate product and that by a household is a final product; cotton used for medical purpose is a final product and that by a cloth manufacturer is a intermediate product.

While calculating national if the value of cotton used to manufacture cloth may also be taken into account, even after cloth manufactured from it is taken into consideration. In other words the value of cotton has been counted twice ie there has been what is known as double counting

This is bound to inflate unduly the volume of national income and it may work out to be many times the actual. This would lead to over estimation of national income.

b) It is also difficult to calculate the value of durable consumer goods, such as refrigerators etc.

2] Existence of non-monetised sector

There exists a large non-monetised sector in developing countries like India.

a) Agriculture still being in the nature of subsistence farming in the developing countries, a major part of the output is consumed at the farm itself and a part of the production is exchanged for other goods and services. It is difficult to estimate such production and consumption while calculating national income.

b) In many developing nations, there is this issue that goods and services are traded through barter, i.e. without any money. Such goods and services should be included in accounting of national income, but the absence of data makes this inclusion difficult.

3] Lack of occupational specialization [Absence of reliable classification of occupation]

There is generally absence or lack of a clear cut classification of occupations in many countries especially in developing countries. This lack of occupational specialization makes calculation of national income by product method difficult.

For instance, besides cultivation, farmers may be engaged in supplementary occupations like dairy farming, poultry, cloth making, as labour in industry during the slack season etc.

Thus it is difficult to determine the income of individuals who may be engaged in more than one occupation and it is difficult to decide the occupation to which he belongs. Therefore there may be over estimation of income in one sector/occupation and under estimation in the other. As a result of this it becomes difficult to calculate national income.

4] Inadequate and unreliable data

One of the most important difficulties in calculation/estimation of national income is the absence of reliable and adequate data. Without reliable and adequate data, it is not possible to estimate the volume of national income.

a) In many cases individuals especially in developing countries do not keep their accounts properly due to lack of education, illiteracy, or lack of necessary habits for the same. Consequently, a reliable picture may not emerge.

b) In the rural areas there are certain classes like the village money lenders, indigenous bankers etc, who maintain secrecy about their transactions and as such, it is not possible to know the volume of their income and consequently, the real volume of national income is not known.

c) Adequate and correct production and cost data are not available especially in the developing countries. For example data relating to

i. Production of crops, fishery animal husbandry, forestry etc

ii. Petty shop keepers, construction workers, small enterprises etc

iii. Income received by professionals like doctors, lawyers etc, employed in the service sector, may not be accurately recorded and disclosed for various reasons. In many cases, these people do not disclose their real income as they want to evade certain taxes, like personal tax etc.

d) Similarly people earning from subsidiary sources do not disclose their income received from such sources.

e) Data on consumption and investment expenditures of rural and urban population may not be available.

f) Data on unearned income may not be available.

Moreover there is no machinery for collection of such data in developing countries. Therefore national income estimate may not be accurate.

5] Capital gains or losses

a) Capital gains or losses, which accrue to the property owners by increase or decrease in the market value of their capital assets or changes in demand, are not included in the gross national product, because these changes do not result from current economic activities.

b) Identifying Factor Incomes ie separating factor incomes and non factor incomes is also a problem. Factor incomes are those paid in exchange for factor services like wages, rent, interest etc. Non factor are sale of shares selling old cars property etc., but these are made to look like factor incomes and hence are mistakenly included in national income.

6] Depreciation

It is also difficult to estimate depreciation on capital consumption. Depreciation is  “wear and tear of capital assets” ie wear and tear of capital goods, buildings etc, due to their use in the process of production. Idleness of an asset, outdated assets and loss in the value of capital may also occur in the value of capital due to fire floods and other calamities.

Depreciation leads to loss in the value of the asset. To arrive at net or exact or actual value, loss in the value of capital assets has to be deducted from the gross value.

Depreciation of capital assets will depend on the technical life of the capital asset, the intensity of its use, nature of the asset, regular care and maintenance etc.

There are no uniform, common or accepted standard rates of depreciation applicable to the various capital assets. Therefore to calculate depreciation many reasonable assumptions, which involve an element of subjectivity, have to be made.

Generally such calculations are made on the basis of rough estimates which, by no stretch of imagination, can be accurate. It is therefore difficult to estimate depreciation on capital consumption accurately.

Therefore national income estimate may not be accurate.

7] Valuation of inventories

It is also difficult to valuation of inventory as it consists of raw materials, intermediate goods, semi- finished and finished good in the stock of producers, at the end of the given period of time or the year of accounting is known as inventory.

All inventory changes, whether positive or negative, are included in the gross national product. Inaccuracy in measuring the value of inventory, will distort the value of the final production of the producer. Therefore inventories require careful assessment.

8] Illiteracy and ignorance [Lack of maintaining proper accounts]

Majority of farmers and small producers in developing countries are illiterate, ignorant and not habituated and to keep any account of their productive activities. So they cannot give information about the quantity or value of their output. Hence the estimates of production and earned incomes are simply guesses. Consequently, a reliable picture may not emerge.


It will be seen from the above discussion that some of the difficulties are not very serious and if the people and the government observe certain disciplines they can be overcome.

Similarly when developing countries become developed, some of the difficulties which are peculiar to them can also be avoided.

Thus many of the difficulties and problems in computing national income can be solved. Much depends upon the people themselves.

Posted in General Economics