LEARNING OUTCOME 5
NATIONAL INCOME
NATIONAL INCOME
National Income is a measure of the value of economic activity in an economy.
Nominal National Income is the money value, whereas Real National Income
eliminates the effect of inflation.
The basis of National Income is Aggregate Monetary Demand which comprises:
Consumption Spending (C)
+
Investment Spending (I)
+
Government Spending (G) + Exports (X)
In an open (trading) economy, National Income comprises:
Consumption(C) + Investment(I) + Government(G) + Exports(X) – Saving(S) – Taxation(T) - Imports(M)
INJECTIONS
Firms
Government
Saving
(X)
Investment
Exports
WITHDRAWALS
(I)
(G)
(C)
(M)
CIRCULAR
FLOW OF
INCOME
(Y)
Imports
(T)
(S)
Households
Taxation
NATIONAL INCOME
As long as -
total injections
Investment
+
Government
+
Exports
equal
=
total withdrawals
Saving
+
Taxation
+
Imports
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 and
employment will fall.
Similar to water in a bath, when the taps inject
water 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 MULTIPLIER
The 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:
If consumers choose to spend two thirds of any rise in income then they save
the other one third. This means the multiplier is 1
ie 3.
1/3
When the multiplier has a value of 3 this means a Government, seeking to generate
additional 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).
The reason for the multiplier effect is because when 2/3 of any extra income is
spent, 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 INCOME
National income in an economy is important since it is the level of economic
activity which creates employment for labour and all the other resources.
If we plot all spending on the graph
E=Y
starting with Consumption spending (C),
Expenditure
C+I+G
C+I
C
then add on Investment spending (I),
then Government spending (G) - C+I+G
represents Aggregate Monetary Demand.
When AMD is insufficient to employ all
resources, there is a deflationary gap.
FE
Income
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 create
a 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 CALCULATING
NATIONAL INCOME
INCOME METHOD
OUTPUT METHOD
EXPENDITURE METHOD
Gross Domestic Income Gross Domestic Product
+
+
Net Income
from Overseas
+
Net Income from Overseas
and Exports
-
Net Income
from Overseas
Imports
=
=
Gross National Income
=
Gross National Product
-
-
Depreciation
Depreciation
=
=
Net National Income
Gross Domestic Expenditure
=
Net National Product
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 earned
from, or output produced for, or expenditure on, replacement goods (which do not
increase the total stock of goods available) and not additional new goods.
USING NATIONAL INCOME
STATISTICS
Allows comparisons of standard of living between countries provided consideration
is 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
• different countries spend different proportions of national income on capital
goods and defence which do not immediately impact on standard of living
Allows comparisons over time provided consideration is given to:
• the rate of inflation therefore
• use ‘real’ values rather than’ nominal’ values
QUIZ
What does AMD stand for?
What makes up AMD?
Name 3 injections.
Name 3 withdrawals.
AGGREGATE MONETARY DEMAND
CONSUMPTION, INVESTMENT, GOVERNMENT
SPENDING AND EXPORT
INVESTMENT, GOVERNMENT SPENDING AND
EXPORTS
SAVING, TAXATION AND IMPORTS
What is national income equilibrium?
LEVEL AT WHICH INJECTIONS = WITHDRAWALS
Describe the multiplier effect.
EXTRA SPENDING MULTIPLIED UP GENERATING
NATIONAL INCOME LARGER THAN INJECTION
How is the value of the multiplier
determined?
INVERSE OF MARGINAL PROPENSITY TO LEAK
What is an inflationary gap?
SPENDING TOO HIGH FOR AVAILABLE CAPACITY
What is a deflationary gap?
SPENDING TOO LOW FOR AVAILABLE CAPACITY
What are 3 methods of calculating
national income?
When using national income statistics
what must be borne in mind?
INCOME, OUTPUT AND EXPENDITURE
DIFFERENCES IN POPULATION, INFLATION, WORK
CONDITIONS, DISTRIBUTION OF WEALTH ………….