A number of difficulties arise in measuring the national income accurately. National income accounting involves both conceptual as well as statistical difficulties.
A. Conceptual Difficulties
The conceptual difficulties in measuring national income include:
Problem of Definition
The major problem arises when defining the composition of national income. Ideally, national income includes all the goods and services produced within a certain time period. But there are times when it is difficult to decide which goods to include and which to exclude. A clear distinction between finished goods and intermediate goods is difficult.
For instance, the paper used as office stationery is a final product, but if the paper is used in a book, it becomes an intermediate product.
Price Changes
Change in price is one of the greatest challenges in computing national income. The continued change in the price of raw materials, production process, and the final goods make it difficult to get determine the actual cost of the goods and services when they arrive at the market.
Double Counting
Double counting is an issue that is most prominent while determining national income. It refers to the counting the value of a good more than once.
For instance, a woodcutter sells a log of wood at 2 dollars to a carpenter. The latter makes a table of it and sells it to a furniture vendor at 4 dollars. Now if the price of wood is counted every time then, national income increases by 6 dollars whereas the actual increase is only 4 dollars i.e. the final price of the final product.
The problem of inaccuracy is seen when the value of national income is inflated due to double counting. So, only the value of final good should be taken into account to estimate the national income accurately.
Income from Foreign Investors
This problem arises especially with countries where MNCs reside. Although MNCs are doing well in the host country, a part of their total income goes to the mother company located in a foreign land. So, the actual national income of the host country for the current year cannot be accurately determined.
Services rendered with no Accountability
Another major problem in computing national income is the inclusion of non-monetary transactions that are carried out within an economy. Although the transactions are carried out within the economy, they are not recorded with monetary value. This reduces the overall income of a nation.
For instance, the household work carried out by women are not for commercial purpose and are not considered in monetary terms while calculating national income.
B. Statistical Difficulties
The statistical difficulties are mostly seen in the developing as well as under-developed countries. Some of the statistical difficulties in measuring national income include:
Unrealistic and Inadequate Statistics
Especially in the underdeveloped and developing countries, it is difficult to obtain statistics due to the problem of illiteracy. No proper accounts are maintained for production or expenditure. Besides this, producers provide fabricate data in order to evade income tax. Due to these reasons, the true picture of national income cannot be obtained.
Existence of Barter System
Even in the modern era, barter system continues to exist in the backward communities. People exchange goods for goods and service are paid in kind. No transactions are not carried out in monetary terms. Under these circumstances, a correct estimate of national income is not possible.
The Underground Economy
The underground economy exists in any economy. This includes illegal activities like gambling, smuggling, drugs, etc. These illegal forms of economic activity are not reported to the authority for tax purpose and are excluded from national income accounts.
Self-consumed Production
Economies in developing countries are involved in producing goods and services for self-consumption rather for commercial selling. Usually, some parts of the produced goods are either consumed by the producer themselves or bartered for some other goods with consumers and other entities in the market. This non-monetised sector makes it difficult to calculate national income.
Lack of Occupational Classification
People in under-developed countries engage themselves in one or more occupations to earn their livelihood. There is no clear-cut division of occupations and it is very difficult to identify the incomes of the individuals from a specific job or other occupational undertakings.
Lack of Common Denominators
The numerous economic activities undertaken by individuals, business firms, and governmental bodies cannot be reduced to a common measurable denominator.
For instance, the income earned by the mayor of a state cannot be measured in same terms as that of a vegetable vendor. This is one of the reasons why national income accounting is not able to determine the true picture of how an economy is functioning.