Introduction
Understanding the basic concepts of income and expenditures, assets and liabilities, profit and loss are of high importance not only for the examination purposes but also for all the proper functioning of organizations and their success. Vedantu hence provides you with an article that will help you understand more regarding the Expenditure Method and Income Method that will help you not only as a part of the syllabus but will also help you understand its application that will be needed in the future work environment. These concepts also govern some of the important aspects of the economy and hence if you would like to know more about the economy it is safe to say that you need to understand the basics of Expenditure Method and Income Method.
Before proceeding further, with the Expenditure and Income method of calculating national income, let us know what National Income is?
What is National Income?
National Income is also termed as National Income at factor cost indicating a total amount of income that is earned by resources for the corresponding contribution towards labor, land, capital as well as organizational ability.
The methods of national income for computation would have to necessarily take into consideration the sum of the income accrued from production factors in the form of wages, rent, profit and interest.
The National Income Formula may Comprise:
National Income = Net National Product + Subsidies – Indirect Taxes
Or, Gross National Product – Depreciation + Subsidies – Indirect Taxes
Or, National Income = C + G + I + (X – M) + NFIA – Depreciation – Indirect Taxes + Subsidies
[Where,
C = Consumption
G = Government expenditure
I = Investment
X – M = Export minus Import
NFIA = Net Factor Income from Abroad]
On dividing the National Income by population, the per capita income can be found out. The above figure shows that per capita income in 2019 has grown at the fastest rate reaching 11.1%.
The methods of national income accounting include both income and expenditure methods for calculation.
Income Method of Calculating National Income
The income method formula takes into consideration that the measurement of National Income is representative of the flow of income factor. The four elements of production in this regard include:
Land (which receive rent)
Labor (which receive salary/wages)
Capital (which receive interest)
Entrepreneurship (which receive profit in the form of remuneration)
The Formula of Income Method is:
National Income = Employees’ compensation + Net income + Operating surplus (W + R + P + I) + Net Factor Income generated from abroad
[Where,
W = Salaries and Wages
R = Rental income
P = Profit
I = Mixed Income]
Expenditure Method of National Income
The expenditure method is one of the effective ways of national income accounting in which the measurement of the same is taken as a flow of expenditure from government consumption, net exports, and gross capital formation.
The Formula is –
National Income = C + G + I + NX
[Where,
Household consumption is represented by C
Government expenditure is represented by G
Investment expense is represented by I
Net exports are represented by NX]
If you seek to know more about methods of national income accounting, you are advised to attend our online classes. You can avail of solved questionnaires, study materials in PDF format, and a host of other resources.
FAQs on Expenditure Method vs. Income Method: National Income Accounting
1. What is the fundamental difference between the Income Method and the Expenditure Method of calculating National Income?
The fundamental difference lies in the perspective of measurement. The Income Method calculates national income by summing up all the factor incomes (wages, rent, interest, profit) earned by the factors of production within an economy. In contrast, the Expenditure Method calculates it by summing up all the final expenditures incurred on goods and services, such as consumption, investment, and government spending. Essentially, one measures the earnings, and the other measures the spending.
2. What is the Expenditure Method of calculating National Income as per the CBSE 2025-26 syllabus?
The Expenditure Method measures the final expenditure on the Gross Domestic Product (GDP) at market prices during an accounting year. It sums up all the spending on final goods and services produced within the domestic territory of a country. The formula used is GDPMP = C + I + G + (X-M), where C is private consumption, I is investment, G is government spending, and (X-M) represents net exports.
3. What are the main components of the Expenditure Method formula (C + I + G + (X-M))?
The main components of the Expenditure Method are:
Private Final Consumption Expenditure (C): Spending by households and non-profit institutions on final goods and services.
Gross Domestic Capital Formation (I): This is the investment expenditure on capital goods by firms, including fixed capital (like machinery) and changes in inventory (stocks).
Government Final Consumption Expenditure (G): Spending by the government on various administrative services, defence, and law and order.
Net Exports (X-M): The difference between the value of a country's exports (X) and its imports (M).
4. What is the Income Method of calculating National Income?
The Income Method calculates national income by adding up all the incomes earned by the factors of production in exchange for their services. This method arrives at Net Domestic Product at Factor Cost (NDPFC) by summing up:
Compensation of Employees: Wages and salaries paid in cash and kind.
Operating Surplus: Income from property and entrepreneurship, which includes rent, interest, and profit.
Mixed-Income of Self-Employed: Income generated by self-employed individuals and unincorporated enterprises where factor incomes cannot be separated.
5. Can you give a simple real-world example of how the Expenditure Method works?
Imagine a very simple economy that only produces bread. In a year, households buy ₹500 worth of bread (Consumption), the bakery invests ₹200 in a new oven (Investment), the government buys ₹100 of bread for its cafeterias (Government Spending), and the country exports ₹50 worth of bread. The National Income (GDP) by expenditure method would be the sum of all these: ₹500 + ₹200 + ₹100 + ₹50 = ₹850.
6. Why do the Income, Expenditure, and Production methods theoretically result in the same National Income figure?
The three methods are different perspectives of the same economic activity, based on the principle of the circular flow of income. The Production Method measures the value of goods and services produced. This production generates income for the factors of production (labour, capital), which is measured by the Income Method. This income is then spent by households and firms to purchase the goods and services, which is measured by the Expenditure Method. Therefore, in a closed economy without leakages, Total Production = Total Income = Total Expenditure.
7. What are some key precautions to take when using the Expenditure Method to avoid errors?
To ensure accuracy with the Expenditure Method, one must take several precautions:
Avoid Double Counting: Only expenditure on final goods and services should be included. Spending on intermediate goods (like a bakery buying flour) must be excluded.
Exclude Second-hand Goods: The sale and purchase of second-hand goods should not be included, as their value was already counted in the year of original production.
Exclude Financial Transactions: Expenditure on shares, bonds, and debentures is not included as it represents a transfer of ownership, not production of new goods or services.
Exclude Transfer Payments: Government transfer payments like pensions and scholarships are excluded because they do not correspond to any production of goods or services.
8. How are transfer payments, like old-age pensions, treated in National Income accounting and why?
Transfer payments, such as old-age pensions, scholarships, and unemployment allowances, are excluded from the calculation of national income, whether using the income or expenditure method. This is because these payments are unilateral transfers for which no productive service is rendered in the current year. They are simply a transfer of income from the government or one entity to another and do not contribute to the current flow of goods and services in the economy.
9. Why isn't Gross Domestic Product (GDP), calculated by these methods, a perfect indicator of a nation's well-being?
GDP is not a perfect indicator of well-being because it only measures the monetary value of production and has several limitations. It does not account for:
Non-Monetary Exchanges: Services provided by homemakers or barter transactions are not included.
Distribution of Income: A high GDP could be concentrated in the hands of a few, masking widespread poverty.
Externalities: It ignores negative impacts like pollution and positive impacts like better public health which affect welfare.
Composition of Output: It doesn't distinguish between the production of capital goods (machinery) and harmful goods (like cigarettes).
