ECONOMICS FORM SIX TOPIC 2: NATIONAL INCOME

Definition: Is the total flow of income obtained by individual in an economy within a year.

OR

-Is the total value of all the expenditure by different people, government within an economy at a period of one year.

OR

-Is the value of final goods and service produced by a given country within a year.

NATIONAL INCOME ACCOUNTING / MEASURES OF NATIONAL INCOME

National income measures are used to estimate the value of goods and services produced in an economy.

The following components are used in calculation of national income -:

Gross Domestic Product (GDP)

The most important concept of national income is Gross Domestic Product. Gross domestic product is the money value of all final goods and services produced within the domestic territory of a country during a year.

Algebraic expression under product method is,

GDP=(P*Q)

where,
GDP=Gross Domestic Product
P=Price of goods and service
Q=Quantity of goods and service
denotes the summation of all values.

Gross National Product (GNP)

Gross National Product is the total market value of all final goods and services produced annually in a country plus net factor income from abroad.

Thus, GNP is the total measure of the flow of goods and services at market value resulting from current production during a year in a country including net factor income from abroad. The GNP can be expressed as the following equation:

GNP=GDP+NFIA (Net Factor Income from Abroad)
or, GNP=C+I+G+(X-M)+NFIA

Hence, GNP includes the following:

Consumer goods and services.

Gross private domestic investment in capital goods.

Government expenditure.

Net exports (exports-imports).

Net factor income from abroad.

Net National Product (NNP)

Net National Product is the market value of all final goods and services after allowing for depreciation. It is also called National Income at market price. When charges for depreciation are deducted from the gross national product, we get it. Thus,

NNP=GNP-Depreciation
or, NNP=C+I+G+(X-M)+NAIF-Depreciation

National Income (NI)

National Income is also known as National Income at factor cost. National income at factor cost means the sum of all incomes earned by resources suppliers for their contribution of land, labor, capital and organizational ability which go into the years net production.

Hence, the sum of the income received by factors of production in the form of rent, wages, interest and profit is called National Income. Symbolically,

NI=NNP+Subsidies-Interest Taxes
or,GNP-Depreciation+Subsidies-Indirect Taxes
or,NI=C+G+I+(X-M)+NFIA-Depreciation-Indirect Taxes+Subsidies

Personal Income (PI)

Personal Income i s the total money income received by individuals and households of a country from all possible sources before direct taxes. Therefore, personal income can be expressed as follows:

PI=NI-Corporate Income Taxes-Undistributed Corporate Profits-Social Security Contribution+Transfer Payments
DISPOSABLE PERSONAL INCOME {DPI}

DPI =PI –direct taxes – fines – fee= cost + saving

Equate (i) and (ii)

C + I =C + S

I= S

Where I = Investment

S = saving

C = consumption

Qn 1: Given national income at market price is 100,000,000, indirect taxes 10,000,000 and subsidy 5,000,000. Calculate national income at factor cost

Soln:-

NI = NNP – Indirect taxes + subsidy

= 100,000,000 – 10,000,000 + 5,000,000

= 90,000,000 + 5,000,000

=95,000,000/=

2: Given hypothetical economy of country x where GNP is 400,000,000, consumption of capital 4mil, Outflow of good and service 120mil, inflow of goods and service 180mil taxes 5mil, subsidies 30 mil. Calculate

Net factor income from abroad = GNP – GDP

METHODS OF CALCULATING NATIONAL INCOME

1. OUTPUT APPROACH / PRODUCT METHOD.

This method adds all the sectors value of output in an economy or output approach measures the value of an economy at the source of production. It sums value of output from sector like mining, wildlife, and manufacturing e.t.c.

In output approach added by all firm in different stages of production can be added to get national income using output approach.

Example:

Suppose we have maize producer who sells maize to a miller at TSHS1500 per kilogram the miller changes the maize into favor and sells it to traders at TSHS 1000. Traders sells to the final consumer at TSH 2100/= to get the income using the value added method we add

Maize 1500

Value of flour 400

Value

2. EXPENDITURE APPROACH

This is a method where the value of spending on all final goods and service is added up to get the value of national income.

Expenditure =E = C +G + I + (X – M)

Where C – personal consumption expenditure

G-expenditure by the government

I-expenditure on investment

X-expenditure on export by buyers

M-expenditure on import

Note: (X – M)- Gives net export

GDP = C + I + G +(X – M)

GNP = GDP + Net foreign income

= C + I + G + (X – M) + NFI

3. INCOME APPROACH

This method adds all incomes received by factor of production. They include wages, profit, interest, and rent.

GDP = Wages + profit + rent + interest + operating surplus.

CIRCULAR FLOW OF NATIONAL INCOME

Qn: what is circular flow of national income?

Given: a simple closed economy with mainly two sectors i.e. household and firm (business) the flow of income can be illustrated as follows.

In the above economy the following assumptions have been used

It is a closed economy i.e there is no foreign trade

There are no leakages , every income received must be spent, e.g.; Saving-taxes-import

The economy has two sector namely household and firm

The household provide factors of production to firm and spend all the income it receives in purchase of goods and services.

It assumes there are no injections i.e there is no income arising from expenditure outside the economy.eg Investment-Government expenditure-Exports

Each time something is produced and sold its value is equal to the purchases expenditure .The purchaser expenditure will be received as income by those who produced. Hence E=0=Y. National expenditure is equivalent to national output equivalent to national income.

THE DETERMINANT OF THE SIZE OF NATIONAL INCOME

Availability of resources and their utilization

These resources include natural resources, man-made and human resources; the more the resources utilized the more the income

Political and social stability

The availability of entrepreneur force in the economy

The size of capital accumulated by a country

The more the capital good the more the national income due to the investment

The level of technology

Advancement of technology leads to higher production leading to a higher national income

Government policy

This is particularly in developing policy such as infrastructure policy and privatization, licensing etc.The more the government policy is complicated the lesser the entrepreneur the lesser the output and hence the lower the national income.

2. The efficient of labor force

The more the labor is inefficient the lesser the quality and output affecting the size of National income.

USES OF NATIONAL INCOME STATISTICS

National income statistics help to show the growth rate of an economy annually i.e. the government computes the national income and compares it with the other year and calculate the % of growth rate.

National income statistics helps to get per capital income.

Per capital income =National Income/Population

It is used to determine the effectiveness of the government in tax, revenue collection. The tax revenue collected should be proportional to the National income.

It helps to indicate resource utilization i.e. the more the National income the more the utilization of resources.

It is used for international comparison of economic growth and the performance of a country.

It is used for attracting foreign donors

It helps the government in making decisions on allocation of resource in different sector by accessing the contribution in national income. The best sector is considered in resource allocation.

Is used by the government in making policies e.g. Policies on employments e.t.c

PROBLEMS ENCOUNTERED IN COMPILING NATIONAL INCOME STATISTICS.

Inaccurate data makes it difficult to get correct figure of national income and per capital income

Transfer payment, this are used in calculating personal income it is difficult to know their actual value e.g. The value of a gift

There is sometimes a problem of double counting .some items are included more than once in calculating national income e.g. Work in progress.

There is a shortage of qualified personnel in compiling data

Subsistence economy (non monetary activities)

Illegal activities i.e. black market, social evils

There is a problem of estimating income received from abroad.

Data from self employment activities is not easily available.

KEYNESIAN APPROACH IN THE DETERMINATION OF NATIONAL INCOME EQUILIBRIUM.

According to Keynes national income equilibrium is determined at the intersection of demand and supply. In this argument he stated the following assumptions.

Keynes assumed that there are only two sector in an economy i.e. Household and firm.

The price of products are constant

He assumed that there is no government expenditure.

Keynes assumed that the supply of labor is constant.

Demand; according to Keynes is the total expenditure by the society, it is obtained from consumption and investment i.e. total demand is equal to total expenditure = C+I

Hence Y = C + I

Supply; is the total goods and services produced in a country within a year. According to Keynes supply =consumption + saving because when goods and services are sold the income received is spent on consumption and saving.

Hence total supply = C+S

DD = SS

Y = C+I Y= C + S

C + I = C+S

I = S

Hence; according to Keynes equilibrium in the national income is obtain when investment (I) is equal to saving (S)

RELATIONSHIP BETWEEN CONSUMPTION AND INCOME.

CONSUMPTION: Is the total expenditure by household which gives a satisfaction.

CONSUMPTION FUNCTION: Is a mathematical relationship between consumption and the level of disposable income. It is denoted by.

C= a + by

Where; c is consumption

a is autonomous consumption. This is consumption that does not depend on income. It comes from past saving and borrowing.

b is induced consumption i.e. consumption that depends on income i.e changes with change in income. This is the proportional of the income spent on consumption, it is also called marginal propensity to consume (MPC). it is a slope of consumption function

The consumption function can be illustrated graphically as follows.

Average propensity to consume (APC)

This is consumption per unit of income i.e it is total consumption divide by total income

Marginal propensity to consume (MPC)

Is the additional consumption resulting from additional income

FACTORS AFFECTING/ DETERMINING THE LEVEL OF CONSUMPTION

The level of income (disposable income)

Government expenditure

The higher the government expenditure the higher the consumption

3. The more the taxes, the lesser amount spent for consumption.

4. Prices of goods and service.

The higher the prices of goods and services the lesser the level consumption.

5. A mount of undistributed profits.

The more the profit retain the less the income, the lower the consumption.

6. Changes in interest rate

Low interest rate on loans and savings increases consumption and high interest rate on loans and saving decreases consumption.

7. Population size.

Level of consumptions depends on level of population. When the population is higher the consumption is also higher and vice versa is true.

RELATIONSHIP BETWEEN SAVING AND INCOME

Saving: refers to that part of income which is not spent in the current period.

Saving function: is a mathematical relationship between saving and income.

Qn. Derive the saving function.

Y = C+S…….. (i)

C = a + by….. (ii)

Substitute c in (i) in equation (ii)

Y= a + by + S

Make S the subject

S = y – a – by

S = -a – by + y

= a + y – by

= a + y (1-b)

S= a + (1-b) y

The saving function can be illustrated as follows:-

Average Propensity to Save (APS)

This refers to saving per unit income

APS = S/Y

Marginal prosperity to save (MPS)

Is additional saving resulting from additional income

MPS = ∆S/∆Y

QN: show that MPS + MPC= 1 where MPS is marginal prosperity to save and MPC is marginal propensity to consume.

Soln;

Y = C + S

Assume there is a change in income bringing a both change in consumption and savings

Y = C + S

MPC=C/Y and MPS = S/Y

Divided throughout by change in income

Y/Y = C/Y + S/Y

1 = MPC + MPS

QN. Why is MPS + MPC=1

FACTORS AFFECTING THE LEVEL OF SAVINGS

The level of income

Amount spent on consumption

Rate of interest on savings

Price of commodities

Government expenditure

The level of taxes

Government policy in establishing financial institution and educating people on savings.

MULTIPLIER

Is a change in equilibrium of net national products resulting from a change in investment

Multiplier is the rate of change of national income resulting from changes in the determinant of the national income. It shows the number of times the investment has change to reach to a particular amount of national income.

It is denoted by letter k. k multiplier is equal to change in income over change in investment.

Derivation of the Multiplier

Suppose the equilibrium income is given by Y = C+I

Y_O = C_O + I_O……… (i)

Assuming there is any change in investment leading to a new level of equilibrium

Y_1 = C_(1+) I_1

To obtain a change in income subtract eqn (i) from (ii)

∆Y =∆C + ∆I……… (iii)

The change in I also being a change in C

The in consumption depends on MPC where

MPC = ∆C/∆Y

∆C = MPC × Y……….

Substitute equal (IV) into (iii)

∆Y = Y – MPC ∆ Y + I

Make change in I subject

∆ I = ∆Y – MPC ∆Y

= ∆Y (1-MPC)

Divided throughout by∆ I

∆I/∆I = ∆Y/∆I (1 –MPC)

1 = ∆Y/∆I (1 – MPC)

Divide both sides by (1 – MPC)×1/((1-MPC))=∆Y/∆I

K = ∆Y/∆I(1/((1-MPC)))

K=1/((1-MPC)) OR K =1/MPS

QN1. Given that MPC = 0.2 find the multiplier.
Soln:
K = 1/(1-0.2)=1/0.8
= 1.25

Qn2. Given the MPC = 0.8 find MPS
MPC + MPS = 1
0.8+ MPS = 1
MPS = 1 – 0.8
MPS = 0.2.

Divide both sides by (1 – MPC)×1/((1-MPC))=∆Y/∆I

K = ∆Y/∆I(1/((1-MPC)))

K = 1/((1-MPC)) OR K =1/MPS

QN1. Given that MPC = 0.2 find the multiplier.

Soln:

K = 1/(1-0.2)=1/0.8
= 1.25

Qn2. Given the MPC = 0.8 find MPS

MPC + MPS = 1

0.8+ MPS = 1

MPS = 1 – 0.8

MPS = 0.2.

Qn3: Given ∆Y to be 100 which result from a I of 20 find MPC.

K = ∆Y/∆I = 100/20 = 5

K = 1/(1-MPC)

5/1 = 1/(1-MPC)

5 (1 – MPC) = 1

5 – 5 MPC = 1

-5MPC = 1 – 5

-5MPC/ = -4/
– 5 -5
MPC = 4/
5

Q.N given (a) level of income.

Y = C+G+I (X –M)

=150 + 0.8y + 50 + 30.05y + (20 – 0.1y)

=250 + 0.75y

y- 0.75y = 250

0.25y / 0.25 = 250 / 0.25

Y= 1000

INVESTMENT

What is investment?

Is the expenditure that leads to an increase in the existing stock of capital goods.

The stock of capital should be aimed at yielding a more flow of goods and services in the future.

Autonomic investment: is an investment that does not depend on changes of income e.g.: investment in public goods and services.

Induced investment: is an investment that occurs as a result of changes in income.

FACTORS AFFECT THE LEVEL OF INVESTMENTS.

Level of income

Marginal efficiencies of capital (MEC) i.e. rate of return on use of capital.

Availability of infrastructure.

The size of the market for goods and services produced (level of demand)

Cost of investments. When it is high or low affects the level of investments positively or negatively.

Government policy i.e. tax on import subsidies, privatization policy, and licensing procedure.

Rate of interest on borrowings

Multiplier process

Is the process through which the initial change in income passes through the final stop where all of the income invested is saved i.e. savings is equal to amount invested.

Suppose an investment of 1000million is invested in road construction is made the investment will change into income when it is received. The money will be used in buying construction material and paying the workers and labors; they receive the money and will consume it and save part of that money. Suppose the MPC is 80% then,

According the table above the receiver of the table will consume 800mil and save 200mil, the receiver of 800 will consume 80% which is 640 and save 160 the process will continue until saving is equal to investment.

The amount obtained at the end of the process can also be obtained using the multiplier formula thus.

K = ∆Y/∆I=1/(1-MPC)

K=1/(1-0.8)=1/0.2 5/1=∆Y/1000

∆Y = 5000

There are other forms of multiplier which includes tax, multiplier including.

Tax multiplier = ∆Y

∆ in taxes

Govt expenditure multiplier = ∆Y

∆ in government exp

Foreign trade multiplier = ∆Y

∆ in net export

Income multiplier = ∆Y

∆ in total income

Assumption of multiplier

The multiplier assumes that all income is spent on consumption.

It assumes MPC is constant

It assumes there is no scarcity of goods and services such that any & additional income must be spent in consumption,

It works in a closed economy where no effect of imported inflation.

It assumes that there are no leakages and injections.

Limitations of multiplier process in LDC’S. Discuss

Lock of well established capital industries as a result of any investment established must involve the purchases of capital goods such as machines from developed country. The importation of capital goods from abroad causes a leakages (withdraw) to a multiplier, where it assumes there is no leakages. (outflow of income to abroad)

Lack of entrepreneur abilities in LDC’S thus for any investment must involve importation of experts from abroad which may cause leakages to the multiplier because it involves outflow of income.

Poor productivity due to low level of technology hence output produced in LDC’S is very low as a result LDC’S are forced to import goods and services from abroad which also causes leakages to the multiplier because it involves income outflow.

Poor infrastructure in LDC’S due to poor means of transport and communication it becomes cheaper sometimes to import goods and services from abroad than to buy it within a country resulting into leakages of multiplier process.

Low wages paid to the workers in LDC’S in order to meet their day to day transaction of buying goods and services hence they have to borrow money and when they received their income they use it to settle the debts. Hence affecting multiplier process.

ACCELERATION PRINCIPLE

Show the relationship between changes in investment resulting from a change in income. It is brought about as follows, after multiplier process has taken place leading to an increase in income, this income will be invested by investors in different sectors until the amount is over for example:-

If a change in investment of 1000 bring a change in income of 5000 the multiplier process and the 5000 is then invested to bring a total investment at the end of 20,000 then the maceration is 4.

Accelerator is denoted by letter V where V is equal to change in investment over change of income

V = ∆I/∆Y

INCOME INEQUALITY

Is the difference of income among different people

Forms of income inequality

Individual income inequality

Is difference in income among different individual result from different opportunities

2. Regional income Inequality

The difference in regional depends on the availability of natural resources and their utilization.

3. Income in equality among sectors.

Inequalities in a sector depend on the sector income e.g. TRA workers and teachers.

4. Rural – urban inequality

CAUSES OF INDIVIDUAL INCOME INEQUALITY

Education level

Inheritance

Social evils include corruption, smuggling, prostitution, black traffic etc.

Opportunities and luck

Ownership of major means of production

The tax system/ structure e.g. Regressive tax, high income in tax

Natural abilities i.e. talents.

ADVANTAGES OF INCOME INEQUALITY

It brings about / good relationship and respect among people in the community

It encourages mobility of labor

It leads to creativity

It enables different, tax system to exist e.g. progressive tax system

It improves relationship between employee and employer.

It helps in promoting government policy like poverty eradication.

DISADVANTAGES OF INCOME INEQUALITY

It creates/ led to political social problem/ instability.

It lead to social evils

It leads to exploitation of man by man.

It discourage investment to low income growing

It leads to rural – urban migration as result of rural – urban income difference.

It leads to decrease in consumption affecting demand

It leads to economic dualism i.e. Two groups of rich and the poor

MEASURES TO CONTROL INCOME INEQUALITY.

By providing subsidies to low income group

By restricting the tax system hence using progressive tax system.

Providing equal opportunities to all such as free education

Control of major means of resources on ownership i.e. through nationalization policy.

Creating more employment opportunities

Government policies. The govt should indicate policies which will be geared to reduce/eradicating income inequality e.g. Family planning.

METHODS OF SHOWING INCOME INEQUALITY.

The Lorenz curve.

Meaning: It is locus of points that shows cumulative percentage population and cumulative percentage income

It is used to show how even/ uneven the income distribution is.

In interpreting the data from Lorenz curve, the following are important.

The further the curve from the line of perfect equality the poorer distribution of income.

The closer the curve from the line of perfect equality the better income distribution.(The more the equality the income is distributed)

In drawing a Lorenz curve the data is grouped into groups of fifths or %

Cumulative data is used in drawing

Round of spending	Increase in Y consumption in Y	Cumulative income consumed	Savings	Cumulative saving
		1000
		1800	200	200
			160	360

LORENZ CURVE

Interpretation

The 5th fifth or upper fifth own 11 times of wealth/ income more than the lower fifth i.e. 47/4 = 11.75

The upper fifth own 6 times more the 2nd fifth i.e. 47 /7 = 6.7

The upper fifth own 1 times more than the 4th fifth i.e. 47/ 30 = 1.6

THE CONCEPT OF FULL EMPLOYMENT, INFLATIONARY GAP AND DEFLATIONARY GAP

FULL EMPLOYMENT

Is a situation where all persons who are willing and able to work are employed, during full employment the resources are fully utilized and national income is at maximum.

INFLATIONARY GAP

This is a situation where aggregate supply (consumption + saving)

= C+ S is lesser than aggregate demand (consumption + investment) i.e. C + S (C + I hence S ‹ I

DEFLATIONARY GAP

This is a situation where aggregate expenditure is lesser than aggregate supply. The gap shows the amount at which the expenditure should be increased to attain full employment.

PER CAPITAL INCOME

QN1.What is per capital income?

Is the income of an individual out of the national income.

PER CAPITAL INCOME= (NATIONAL INCOME)/(TOTAL POPULATION)

Per capital income is not a good indicator of standard of living (welfare) of the people in a given country due to the following reasons:Per capital income doesn’t put into consideration the distribution of income among the people. It assumes that all people earn the same income i.e. employed & none employed.

The size of per capital income depends on size of National income.

National income value includes all expenditure even those which does not reflect to welfare like buying weapons e.t.c which does improve standard of living.

2. The value of National income depends on the price of commodities. Higher prices leads to higher national income, higher capital hence low standard of living.

3. Per capital income depends on the size of population. The Lower the population the higher per capital income this might not be truth for better living standard.

4. National income and per capital income might be higher because of incorrect data.

5. The National income does not take into account the social cost in the process of production such as pollution, health hazards etc. which also affects the welfare of people.

6. Different countries have different exchange rate making it difficult to compare per capital income and standard of living.

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