Income Method

National income is the accumulated value of total goods and services produced by a country within a financial year. It is the net outcome of all economic activities that takes place in a country and valued in terms of money. National income is measured using three methods, income method, expenditure method and product method.

Income Method Definition

Income method calculates national income based on the flow of factor revenues. There are four factors associated with every production activity; these are land, labour, capital and entrepreneurship. Labours receive their wages, the land gets rent, capital accrues interest, and entrepreneurship gets profit, each earning through the individual means.

Apart from that, self-employed individuals like doctors, CAs, advocates, etc. employ their own capital and labour. Thus, their income is regarded as mixed-income.

Therefore, in the income method, the national income is measured in terms of these factor payments. Thus, it is also known as ‘factor payment method.’

To arrive at national income using this method, you have to sum up all the individual income occurred in a country within a specific period. In includes wages and salaries, rent of land, interest gained on capital and income of self-employed individuals. This method conclusively indicates the distribution of national income among every income group of a country. 

Income Method Formula

National Income (NNPFC) = Net Domestic Product at Factor Cost (NDPFC) + Net Factor 

Income from Abroad

Here NDPFC = Compensation of Employees + Operating Surplus + Mixed-Income

Here Operating Surplus = Rent + Interest + Profit

Steps of Income Method Formula

  1. Identification and Classification of Production Units

The first step in calculating national income via income method is to identify and segregate the units of production. They are classified into three categories, primary, secondary and tertiary. 

  1. Classify and Estimate the Factor Income

The next step of the income method of national income is to classify factor payments in different categories like wages, rent, interest, profit and mixed-income. Otherwise, they can be classified into compensation to employees, operating surplus and mixed-income.

After classifying, estimate the number of such payments made by enterprises.

  1. Calculating Domestic Income

Summing up all factor incomes of every sector will present the domestic income figure (NDPFC). 

NDPFC = Compensation of Employees + Operating Surplus + Mixed-Income

  1. Estimate NFIA to arrive at National Income

The last step to reach the final National Income figure is to estimate Net Factor Income from Abroad (NFIA) with NDPFC.

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

Components of Factor Income

Factor income is an essential part of the income method. Summing up all the factor incomes within a country for a period resulted in Domestic Income or NDPFC. There are three components of factor income compensation to employees, operating surplus and mixed-income.

Compensation to Employees (COE)

Compensation to employees refers to the remuneration paid by an employer to his/her employees for their productive services. It includes all monetary and non-monetary benefits that employees receive, directly or indirectly. Moreover, COE comprises of 3 elements, these are –

  • Wages in Cash

It consists of every monetary benefit, such as wages, bonuses, commissions, dearness allowance, etc. However, business expenditures incurred by employees or any reimbursements will not be calculated under COE. Such expense reconsidered as intermediate consumption of an enterprise.

  • Wages in Kind

This includes every non-monetary benefits that employees receive from their employers, like home, car, medical and educational facilities. The imputed value of such benefits should be included in national income.

However, facilities which are necessary for work and employees have no discretion in it should not be included here. For instance, uniforms that employees use or vehicles used for business purposes, etc. Such facilities are considered as intermediate consumption.

  • Employer’s Contribution to Social Security Schemes

It includes the contribution employers make in social security plans such as employees provident fund, gratuity, pension plans, etc.

Operating Surplus

Operating surplus is also divided into 3 categories, these are –

  • Rent

Rent arises from the ownership of properties. Income under this head comprises both actual rent and imputed rent. Actual rent is calculated on properties to let out on rent. Whereas imputed rent is rent on self-occupied properties—such rent calculated according to the market value of the property.

  • Interest

It refers to the interest amount received for loaning funds to a manufacturing unit. This interest comprises both actual and imputed interest. Additionally, it also includes interest paid on loans taken for production units.

However, it does not include interest paid by the government against public debt as well as interest on consumer loans. Moreover, interest paid by one company to another is also not included as it is already accounted for in the company books as profit.

  • Profit

An entrepreneur earns profits for his/her contribution to the company. It is a residual income, which the entrepreneur earns after paying other factors of production. 

Mixed-Income

Self-employed individuals and unincorporated business generate this form of income. The mixed-income arises when elements of factor incomes cannot be separated from each other. For example, a doctor running his/her clinic.

Income method is an important chapter of economics. Apart from this, students can also navigate to other chapters available in Vedantu’s website to learn the details of 10+2 economics. Vedantu’s app is also available for use in smartphones and similar devices.

FAQ (Frequently Asked Questions)

1. What is the Income Method?

It is a process of calculating national income by considering the factors income of an economy. Here, the factor income of every section of and the economy is summed up and then by adding the Net Factor Income from Abroad, National Income is determined.

2. What is the formula of Income Method?

National Income (NNPFC) = Net Domestic Product at Factor Cost (NDPFC) + Net Factor Income from Abroad

3. What are the components of Factor Income?

There are three components of factor income, compensation to employees, operating surplus and mixed-income.

4. What is Mixed-Income?

Mixed-income is the part of factor income which is generated by self-employed individuals and unincorporated business. A doctor running his/her clinic or a small neighbourhood grocery shop are examples of mixed-income.