LEARNING OUTCOME 5

NATIONAL INCOME

NATIONAL INCOMENational Income is a measure of the value of economic activity in an economy.

The basis of National Income is Aggregate Monetary Demand which comprises:

Consumption Spending (C) + Government Spending (G) +Investment Spending (I) +

Nominal National Income is the money value, whereas Real National Income eliminates the effect of inflation.

In an open (trading) economy, National Income comprises:

Consumption(C) + Investment(I) + Government(G) + Exports(X) – Saving(S) – Taxation(T) - Imports(M)

Firms

Households

(C) (Y)

(I)

(S)

(G)

(T)

(M)

(X)

WITHDRAWALS

Saving

Taxation

Imports

INJECTIONS

Government

Investment

Exports

CIRCULARFLOW OF INCOME

Exports (X)

total injections

Investment +Government +

Exports

equal total withdrawals

Saving +Taxation +Imports

As long as -

national income is in equilibrium.

If injections are greater than withdrawals national income, output and employment will rise.If injections are lower than withdrawals national income, output andemployment will fall.

NATIONAL INCOME

Similar to water in a bath, when the taps injectwater into the bath faster than the plug withdraws it, then the water level rises.

If the plug withdraws water faster than the taps inject it, the water level falls.

=

THE MULTIPLIERThe proportion of any rise in income which consumers save is known as the

Marginal Propensity to Save.Any additional injection will be multiplied by the inverse of the Marginal Propensity to Save or 1 ie 1

MPS (T) (M) Marginal Leakages

This is known as the multiplier effect and can be used as follows:

When the multiplier has a value of 3 this means a Government, seeking to generateadditional national income of £4.5 bn, only requires to spend an additional £1.5 bn,since a multiplier of 3 will generate the desired £4.5 bn (£1.5 X 3 = £4.5).

If consumers choose to spend two thirds of any rise in income then they savethe other one third. This means the multiplier is 1 ie 3. 1/3

The reason for the multiplier effect is because when 2/3 of any extra income isspent, creating increased demand. Manufacturers will employ extra resources to increase output to meet the demand. When these extra resources are paid for, extra income is earned, 2/3 of which will be spent and so the process goes on.

An additional injection therefore has a ‘multiple’ rather than a ‘one-off’ effect.

NATIONAL INCOMENational income in an economy is important since it is the level of economic activity which creates employment for labour and all the other resources. E=Y

Expenditure

Income

If we plot all spending on the graph starting with Consumption spending (C),

C

C+I

C+I+G then add on Investment spending (I),

then Government spending (G) - C+I+Grepresents Aggregate Monetary Demand.

When AMD is insufficient to employ all resources, there is a deflationary gap.

FE

Keynesian theory would suggest that a Government could increase G and put policies into effect to stimulate C and I in order to make up the gap and createa level of national income sufficient to achieve full employment.Similarly where the level of AMD is higher than necessary for full employment there is an inflationary gap – too much demand for the capacity available.

Keynesian theory would suggest a Government could decrease G and use policies to reduce C and I to eliminate the inflationary gap.

3 METHODS OF CALCULATINGNATIONAL INCOMEINCOME METHOD

Gross Domestic Income

+ Net Income from Overseas

=Gross National Income

-Depreciation

=Net National Income

OUTPUT METHOD

Gross Domestic Product

+ Net Incomefrom Overseas

=Gross National Product

-Depreciation

=Net National Product

EXPENDITURE METHOD

Gross Domestic Expenditure

+ Net Income from Overseas and Exports

-Imports

=Gross National Expenditure

+ subsidies - tax

= Gross National Expenditure

-Depreciation

=Net National Expenditure= =

PROBLEMS WITH NATIONAL INCOME

CALCULATIONS INCOME METHOD:

Only incomes which are earned from productive activity should be counted.

Transfer incomes must not be included since these are paid out of the axes paid by income earners and have already been counted.

Transfer incomes include pensions, benefits and disability allowances.

OUTPUT METHOD:

Care must be taken to avoid double counting by costing production at final value.

Increase in value of stock must be due to real additions to stock and not inflation

Much production is in the ’ black economy’ and therefore goes unrecorded.

EXPENDITURE METHOD:

Should be expressed at ‘factor cost’ by adding back subsidies given and deducting taxes taken.

ALL METHODS:

Depreciation must be deducted since this is value attributed to income earnedfrom, or output produced for, or expenditure on, replacement goods (which do notincrease the total stock of goods available) and not additional new goods.

USING NATIONAL INCOME STATISTICS

Allows comparisons of standard of living between countries provided considerationis given to:

• differing populations – national income per head should be used

• average personal disposable income would take differing tax rates into account

• consideration is given to how national income is distributed within countries

• differences in hours worked and conditions of work should be considered

• social costs and benefits

• exchange rate differences between countries

Allows comparisons over time provided consideration is given to:• the rate of inflation therefore

• use ‘real’ values rather than’ nominal’ values

• different countries spend different proportions of national income on capital goods and defence which do not immediately impact on standard of living

QUIZWhat does AMD stand for?

What makes up AMD?

Name 3 injections.

Name 3 withdrawals.

What is national income equilibrium?

Describe the multiplier effect.

How is the value of the multiplier determined?

What is an inflationary gap?

What is a deflationary gap?

What are 3 methods of calculatingnational income?

When using national income statisticswhat must be borne in mind?

AGGREGATE MONETARY DEMAND

CONSUMPTION, INVESTMENT, GOVERNMENTSPENDING AND EXPORT

INVESTMENT, GOVERNMENT SPENDING ANDEXPORTS

SAVING, TAXATION AND IMPORTS

LEVEL AT WHICH INJECTIONS = WITHDRAWALS

EXTRA SPENDING MULTIPLIED UP GENERATINGNATIONAL INCOME LARGER THAN INJECTION

INVERSE OF MARGINAL PROPENSITY TO LEAK

SPENDING TOO HIGH FOR AVAILABLE CAPACITY

SPENDING TOO LOW FOR AVAILABLE CAPACITY

INCOME, OUTPUT AND EXPENDITURE

DIFFERENCES IN POPULATION, INFLATION, WORKCONDITIONS, DISTRIBUTION OF WEALTH ………….