NATIONAL INCOME
The national income is the money value of the total amount of goods and services produced in country over a period, usually a year.
It is variously called GDP, GNP.
The Circular Flow of Income shows how the national income is created and how it is measured.
The circular flow of income can be explained using a simple model with the following assumptions:
1. Only 2 groups/sectors: households and firms: no international trade, no gov’t.
2. Households spend all their incomes on goods: no savings, no taxes.
3. Firms do not retain any profits for re-investments, and they do not pay taxes.
Households supply factors services: they are paid factor incomes: rent, wages/salaries, interests, profits.(upper section)
Firms supply goods/services: they receive payments by way of consumer spending.(lower section)
In such a simple economic model, what is earned is what is spent; what is spent is equal to the value of goods and services i.e. income = expenditure = output.
In the real world situation,
1. Gov’t enters into the economy both as a producer and a consumer.
2. there is international/foreign trade
3. there are withdrawals/leakages from the circular income flow by way of
a. Savings by households and firms; the savings of firms may be called retained profits.
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Exclusions- items specifically removed from the tax base by law Deductions- subtracted from the tax base rather than fully excluded. Flat tax- one single rate applied to the entire tax base. Progressive tax- rates increase as tax base increases. (Federal income tax) Tax credit- authorized deduction in gross tax liability Real and personal property taxes- Real (real estate) Personal (difficult to ...
b. tax payments by both firms and households
c. spending on imported goods
4. There are injections into the circular flow of income through
d. investment: expenditure on capital goods by private firms
e. Gov’t expenditure both exhaustive and transfers
f. Export earnings: expenditure by foreigners on a country’s goods/services.
The Withdrawal/Leakages, S+T+M, lead to a fall in the circular flow of income.
Injections, I+G+X, add to the size of the circular income flow.
Significance of the Circular Income Flow:
1. It shows national income as a flow of both goods/services and as money between households and firms.
2. The 3 ways of measuring the national all yield the same value.
3. Anytime injections exceed withdrawals, national income will fall.
4. Anytime injections are less than withdrawals, national income will fall.
5. There is equilibrium national income when injections equal withdrawals
6. Gov’t can influence /manage the economy by adopting polices that affect any of the components of the withdrawals or injections.
7. Gov’t polices that affect injections and withdrawals include: Fiscal polices, monetary policies, exchange rates.
Measurement of National Income:
The Circular Flow of Income gives 3 ways of measuring the national income that give the same result: income method, expenditure method, output method.
Income Method: this measures the incomes of people throughout the year. Income is
earned as rent, wages/salaries, interest, profit: these are called Factor Incomes.
Incomes that are not earned by doing any work or supplying a factor of production are not included. Such incomes are called Transfer Payments e.g. Family allowances, students’ allowances/scholarships, welfare benefits. Stock appreciation must also not be counted.
Expenditure Method: this is the addition of all forms of expenditures on goods and services in the country over a year. Such expenditures are on consumer goods and services, investment goods, gov’t spending, plus exports, minus imports.
Output Method: this involves finding out from firms the value of goods and services they produce over a year.
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The gov’t is rather interested in the following:
Gross Domestic Product, GDP: this is a measure of all goods and services produced each year within the borders of a country by both nationals and foreigners alike. It includes the value of exports but does not include incomes earned from productive activities abroad.
Gross National Product, GNP: this is all the incomes earned from productive activities within the country and from abroad but excludes investment activities earned by foreigners i.e. GDP plus investment incomes from abroad minus investment incomes earned by foreigners.
National Income, Net National Income, NNP: This is GNP minus Depreciation. Depreciation here means goods that are provided to replace goods that have worn out. They are for replacement and not an addition to total flow, they are thus excluded.
GDP per head, GDP per capita, is output per head of the population, income per head of the population, average income; it is obtained by dividing the GDP or GNP by the total population. It measures the standard of living of the people in a country. The standard of living is given by the amount of goods a person can lay claim to.
NOMINAL GDP is the GDP at current prices.
REAL GDP is the GDP which is adjusted to take the effect of inflation from it i.e. GDP at current prices. Real GDP per head is what goes to every individual in the country after the money national income has been adjusted to take the effect of inflation out of it.
Real GDP per head is what actually determines the standard of living of people in a country. When Real GDP per head rises, then standard of living has risen, all things being equal.
USES OF NATIONAL INCOME FIGURES
1. Trends in an economy: Whether an economy is growing or not depends on the national income figures. A sustained rise in the GDP figures shows growth as well as the rate of growth. Any fluctuation in GDP figures also tells whether an economy is entering a recession or coming out of it (trade cycle).
2. Living Standards: GDP figures give an indication of the general standard of living in a country, all things being equal. The GDP divided by total population gives income per capita – a measure of the living standard in a country. While material well-being alone cannot be equated with welfare, it is a convenient standard.
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3. The GDP and per capita figures help compare living standards in different countries. This can help determine which country can be a major export target.
4. Figures highlight relationship between parts of the economy: which parts are contributing so much, and whether a country is a primary producer or industrial.
5. The government uses the GDP figures to plan its budget in terms of how much it should spend and how much tax revenue it can collect.
6. Data for forecasting: Businesses and organizations use the GDP date to forecast future levels of economic activity. This helps to decide what they can do or otherwise.
National Income and the General Welfare of People
GDP or Real GDP per capita is when the total amount of goods and services in the country is divided by the total number of people living in the country; it is also called Per Capita Income. It shows the average amount of goods that each resident in a country can enjoy over a year. When it is high, standard of living is high and people are said to be rich. A low real per capita income means people are poor.
But a high GDP/National Income may not mean increased welfare due to the following reasons:
1. Where population growth rate exceeds growth in national income, per capita income will be low; but where GDP grows faster than population, standard of living will be high.
2. Where there is unequal distribution of incomes, a rise in GDP/NY makes just a few people better off, e.g. most of the oil-rich countries.
3. Inflation: in periods of inflation, a rise in national income may not mean people are better. The effect of inflation must be taken from the figures to give Real National Income/Real GDP per head.
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4. Composition: NY could rise due to increased spending on military, luxury or capital goods. The citizens will not be better off.
5. Statistical error: an increased NY figures could arise from mistakes in counting especially when there are not enough qualified statisticians around.
6. Increased GDP may have been attained through longer working hours and dirty working place.
7. More goods could have been obtained through higher external cost e.g. environmental degradation.
Problems in measuring GDP
a. Double-counting i.e. counting the value of goods/services more than once e.g. transfer payments.
b. The subsistence sector of the economy cannot be counted.
c. Black economy: economic activities that are illegal: smuggling, drugs.
d. Inflation: money, the unit of measure of the GDP is not itself stable.
Why it is difficult to use GDP figures for international comparisons.
1. Two countries with the same GDP figures, but different population sizes; then use per capita income to compare.
2. The composition: same GDP size, but more military goods in one country, and more civilian goods in the other.
3. Different sizes of subsistence sector give different GDP figures.
4. Climatic requirements make some items necessary in one country which are not needed in the other country, so their GDP figures will differ.
5. People place different levels of satisfaction or status on the same goods due to differences in culture.
