While calculating national income the issues related to ‘cost’ and ‘price’ also needs to be decided. Basically, there are two sets of costs and prices ; and an economy needs to choose at which of the two costs and two prices it will calculate its national income.
(i) Cost :
Income of an economy, i.e., value of its total produced goods and services may be calculated at either the factor cost’ or the’market cost’.
What is the difference between ‘factor cost’ and the ‘market cost’?
Basically, factor cost is the input cost the producer has to incur in the process of producing something (such as cost of capital, i.e.,interest on Joans, raw materials, labour, rent, power, etc.). This is also termed as factory price or production cost / price. This is nothing but price of the commodity from the producer’s side.
While the market cost is derived after adding the indirect taxes to the factor cost of the product, it means the cost at which the goods reach the market, i.e., showrooms (these are the cenvat / central excise and the CST which are paid by the producers to the central government in India).
This is also known as the ‘ex – factory price’. The weight of the state taxes are then added to it, to finally derive the ‘market cost’. In general, they are also called ‘factor price’ and ‘market price’
India officially used to calculate its national income at factor cost (though the data at market cost was also released which were used for other purposes by the governments, commerce and industry).
Since January 2015, the CSO has switched over to calculating it at market price (i.e., market cost). The market price is calculated by adding the product taxes (generally taken as the indirect taxes of the Centre and the States) to the factor cost.
This way India switched over to the popular international practie. Once the GST has been implemented it will be easier for India to calculate its national income at market price.
(ii) Price :
Income can be derived at two prices, constant and current. The difference in the constant and current prices is only that of the impact of inflation.
Inflation is considered stand still at a year of the past (this year of the past is also known as the ‘base year’) in the case of the constant price, while in the current price, present day inflation is added.
Current price is, basically, the maximum retail price (MRP) which we see printed on the goods selling in the market.
As per the new guidelines the base year in India has been revised from 2004-05 to 2011-12 January 2015).
India calculates its national income at constant prices – so is the situation among other developing economies, while the developed nations calculate it at the current prices.
For statistical purposes the CSO also releases the national income data ar current prices. Why ?
Basically, inflation has been a challenging aspect of policy making in India because of its level (i.e., range in which it dwindles) and stability (how stable it has been). In such situations growth in the income level of the population living below the poverty level (BPL) can can never be measured accurately (due to higher inflation the section will show higher income) and the government will never be able to measure the real impact of its poverty alleviation programmes.
Here, one important aspect of income needs to be understood. Income of a person has three forms-
The first form is nominal income (the wage someone gets in hand per day or per month),
the second form is real income (this is nominal income minus the present day rate of inflation – adjusted in percentage form), and
the last one is the disposable income (the net part of wage one is free to use which is derived after deducting the direct taxes from the real / nominal income, depending upon the need of data).
Unlike India, among the developed nations, inflation has been around 2 per cent for many decades (it means it has been at lower levels and stable, too. This is why the difference between the incomes at constant and current prices among them are narrow and they calculate their national income at current prices. They get more reliable and realistic data of their income).