Question

Explain the theoretical difficulties involved in the measurement of national income.

Answer 1

Difficulties in the measurement of National Income:

The calculation of the national income of a country is a task full of difficulties and complexities. The following difficulties generally arise while estimating national income.

1. Theoretical difficulties
2. Practical difficulties

Theoretical difficulties: This is also known as conceptual difficulties.

1. Transfer payments: Individuals get pensions and unemployment allowances, but whether these should be included in national income is a difficult problem. On one hand, these earnings are a part of individual income and, on the other, they are government expenditures. Therefore, these transfer payments are ignored from national income.
2. Income of foreign firms: According to the IMF viewpoint, the 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.
3. Unpaid services: National income is always measured in money, but there are a number of goods and services which are difficult to assess in terms of money. For example, painting as a hobby by an individual, the bringing up of children by the mother, services are not included in national income as remuneration is not given to them. Also, the services of housewives and the services provided out of love, affection; mercy, sympathy and charity are not included in national income, as they are not paid for. By excluding all such services from it, the national income will work out to be less than what it actually is.
4. Incomes from illegal activities: Income earned through illegal activities such as gambling, black marketing, theft, smuggling etc., is not included in national income. Such goods and services do have value and meet the needs of the consumers. Thus to that extent, national income is underestimated.
5. Treatment of government sector: The government provides a number of public services like defence, public administration, law and order etc. Measuring the market value of such government services is difficult; as the real value of these services is not known, therefore it has become a convention to treat all such services as final consumption. Hence, it is included in the national income.
6. Production for self-consumption: Goods produced for self-consumption such as food grains, vegetables and other farm products do not enter in the market. However, the value of such goods should be estimated at the rate of market price that has been marketed and should be included in national income.
7. Changing price levels: The difficulty of price changes arises in the national income estimate, when the price level in the country rises, the national income also shows an increase even though the production might have fallen when the price level falls., National Income may show a decrease even though production may have increased.