NATIONAL INCOME

Macroeconomics
WHAT IS NATIONAL INCOME?

 NI is the value of all goods and services produced in

the economy in a year.

 It measures the economic performance of a country.

 MEASURING ECONOMIC
PERFORMANCE

This can be done in 3 ways:

1. GROSS DOMESTIC PRODUCT (GDP)

This measures the goods and services that are

produced in the UK no matter who owns the
resources.
2. GROSS NATIONAL PRODUCT (GNP)

Measures the output produced by UK OWNED resources.

Differs from GDP in that output produced in this country

by foreign firms is taken out and output by UK firms
producing abroad is added.

GNP = GDP + Net Property Income from Abroad –

Foreign Income from the UK
3. NET NATIONAL PRODUCT (NNP)

GNP minus the loss in value of capital goods e.g.

machinery. This is called DEPRECIATION

A rise in any of the 3 measures would be deemed to be

ECONOMIC GROWTH, most people would use GDP.
 NOMINAL AND REAL TERMS

 Each of the 3 measures of economic performance can

be expressed in Nominal or Real Terms.
 Nominal Terms

 Nominal terms is also called money terms. Value is

calculated using CURRENT PRICES

 However by doing this it makes it difficult to compare

one years output to another.

 This is because of INFLATION. Which is the general

increase in prices. This could mean that NI has gone up
due to an increase in price and not an increase in
output.
 Real Terms

 In order to measure changes in output you have to

convert the figure into real terms.

 This expresses the change in economic performance

as if their was no inflation – CONSTANT PRICES
 To adjust the figure you have to remove inflation.

 Method: Real NI = Nominal National Income divided

by 1 multiplied by Price Index of Base Year divided by
Price Index of Current Year
CALCULATING NATIONAL INCOME

 There are 3 ways of calculating National Income.

1. THE OUTPUT METHOD

Adds the value of all goods and services produced

by all firms

Must ensure there is no DOUBLE COUNTING – this

means counting the same output more than once
2. THE INCOME METHOD

This is the total amount of incomes earned from

the owners of resources e.g. rent, wages, profit

Does not include transfer income such as

pensions or benefits as they are not involved in
producing output
3. THE EXPENDITURE METHOD

This is total expenditure of all individual citizens,

firms and the Government on goods and services

It does not include expenditure on imports which

are the output of another country
 USES OF NI STATISTICS

NI stats which measures economic activity has many uses:

1. Measure economic growth and changes in standard of

living
2. Aid government decision making – helps assess the state of
the economy
3. Comparison of economic growth and standard of living
between countries.
4. Identify countries that are in need of aid – those with low
NI
5. Calculate contributions that countries should make to
international organisations such as the World Bank and EU
 PROBLEMS MEASURING NI

NI stats need to be accurate however there are problems

1. Errors and omissions – data not collected or calculated

incorrectly
2. Black economy – people don’t show what they earn or
produce – to escape tax or claim benefit
3. Under-recording of output - some goods and services not
included because money doesn’t change hands e.g.
housework, barter, DIY
4. Over-recording through double counting
5. Over-recording through including transfer incomes
 DIFFICULTIES IN USING NI STATS FOR
MAKING COMPARISONS

NI figures are used to make comparisons over time and between

countries but there are problems:

1. Methods of calculating NI may differ over time or between

countries
2. Level of self-sufficiency may differ
3. Standard of living is measured by income per head so population
figures need to be correct as well
4. Stats need to be adjusted for inflation so inflation figures need to
be correct
5. Stats do not show differences in range, design and quality of
products
DIFFICULTIES IN USING NI STATS FOR
MAKING COMPARISONS

6. Stats do not show differences in working conditions,

leisure time or hours worked
7. No differences in income distribution are shown
8. Social costs such as pollution are not taken into
account
9. Spending on defence or space research may increase
output but does little for standard of living of people
 Macroeconomics
TOPIC 1

CIRCULAR FLOW OF INCOME

 TWO SECTOR ECONOMY

 In its simplest form an economy has firms and

households.

 Households own the factors of production which they

provide to firms.

 In return firms give households income, such are rent

and wages.
 Households then spend this income on the output
that firms produce.

 This expenditure becomes income for firms, which is

used to pay incomes to households.

 This creates the circular flow of income.

RESOURCES
FIRMS

INCOME CONSUMER
SPENDING

HOUSEHOLDS
OUTPUT
 CONSUMER SPENDING

 This is how much consumers demand in goods and services

over a period of time.

 When incomes increase so does consumer spending.

 Average propensity to consume

 APC = consumption/income

 Marginal propensity to consume

 MPC = Increase in consumption/Increase in income
 Macroeconomics
TOPIC 1

LEAKAGES AND INJECTIONS

 INJECTIONS

 Injections to the circular flow of income is any

spending that is not consumer spending.

 Three types of injections exist.

 Investment
 Exports
 Government Spending
 INVESTMENT (I)

 This is spending by firms. This is normally on capital

goods, e.g. machinery.
 EXPORTS (X)

 This is the money spent by overseas firms and

individuals on British goods.

 The amount spent is determined by the national

income in foreign countries.

 Can also be determined by the price and quality of

our exports compared to domestic products and
the delivery times and after sales service provided.
GOVERNMENT SPENDING (G)

 This is the spending in the economy of the public

sector.

 The level spent is determined by government

decisions
 LEAKAGES

 This is a withdrawal of money from the circular flow

of income. It is any money that does not go on as
consumer spending.

 There are 3 types:

 Savings
 Imports
 Taxation
 SAVINGS (S)

 This is money that consumers save from their income.

 The higher the level of income the higher the

proportion saved.
 IMPORTS (M)

 This is the amount spent by UK firms and individuals

on foreign goods and services.

 The amount spent on imports is determined by the

level of income in the UK, prices of imports compared
to UK goods and the quality of the imports.
 TAXATION (T)

 This is the amount of revenue collected from central

and local government.

 The amount of tax collected is dependent on the level

of income and the level of spending in the economy.

 The higher the income the more revenue the

government gets. The higher the spending the more
revenue the government needs.
 Macroeconomics
TOPIC 1

DETERMINING NATIONAL
INCOME
 KEYNESIANISM

 Named after the economist John Maynard Keynes.

 This theory states that it is aggregate demand that

determines national income.

 Is looking at the DEMAND SIDE OF THE ECONOMY

 KEY POINTS

 Link between national income and employment –

the higher the level of national income, the greater
the number of workers needed to produce it.

 Full employment level of national income – this is

the maximum output that could be made if all
resources are employed in producing products
which an economy is best at.
NATIONAL INCOME IN A TWO-SECTOR
ECONOMY

 A two-sector economy assumes there is no

government sector and there is no foreign trade. This
is called a CLOSED ECONOMY.

 Therefore the only injection is investment and the

only leakage is savings.
 The equilibrium level is where aggregate demand
(C+I) is equal to income/output or where savings
equal investments.
 CHANGES IN EQUILIBRIUM

 Changes in propensity to save. If consumers save

more of their income, then consumption will fall.

 This means that Aggregate Demand will fall,

income/output will fall, as will employment. National
Income will fall until a new equilibrium is achieved.
 Changes in investment. If firms increase investment
then Aggregate Demand will also rise.

 National Income will increase until a new equilibrium

has been reached.

 However, any change in investment will result in a

bigger change in national income. This is due to the
MULTIPLIER EFFECT.
 THE MULTIPLIER

 Any change in any component of aggregate demand

will have a multiplier effect.

 Often explained by looking at the INVESTMENT

MULTIPLIER
 The investment multiplier measures the change in
national income resulting in a change in investment.

 Change in national income = change in investment x

multiplier
 Assume we have a closed economy with no imports or
government.

 MPC is 0.9 and MPS is 0.1

 A car manufacturer invests £1000 in new equipment. This £1000

becomes income to households. Households will save £100 and
spend £900.

 The £900 of consumer spending becomes £900 of income to

households. These households will save £90 and spend £810.
 The £810 of consumer spending becomes the income
to households, who would save £81 and spend £729

 This process continues until national income is back at

equilibrium. At this point savings will equal
investment. In this example once savings is £1000.
 The size of the multiplier is dependent on the % of
income that is spent and % saved with each round of
income.

 All depends on the marginal propensity to save

(MPS).
 MPS = Change in savings
Change in income

 Multiplier = 1 or 1
MPS 1-MPC

 If the MPS is 0.1 then the multiplier would be 10. This

means that national income would increase by ten times
the amount of the increase in investment.
 In our example this means that the new equilibrium of
national income would be £10000 more than it was
before.

 Savings would have increased by £1000 to equal the

increase in investment.
 NATIONAL INCOME IN AN OPEN
ECONOMY

 An open economy means that there is government

activity and international trade.

 This changes the components of aggregate demand.

 AD in a closed economy is C+I

 AD in an open economy is C+I+G+(X-M)

 Equilibrium is still when AD equals income/output.

 Or where leakages = injections. However it is more

than just savings and investments.

 In an open economy leakages are Savings (S), Imports

(M) and Taxation (T) and injections are Investment (I),
Exports (X) and Government Spending (G).
 THE MULTIPLIER IN AN OPEN
ECONOMY

 The theory of the multiplier remains the same.

 Any increase in an injection will lead to a bigger

increase in national income.

 However, this time it is not only Investment that

might have a multiplier effect; it is also Government
Spending and Exports.
 Working out the multiplier is still the same, however,
this time you have to take in to consideration not only
MPS, but also Marginal Propensity to Import (MPM)
and the Marginal Rate of Tax (MRT).

 Therefore the multiplier can be worked out as:

 1 or 1
1-MPC MPS+MPM+MRT
 THE IMPORTANCE OF THE
MULTIPLIER

 An increase in any injection into the circular flow of

income will increase national income by more than
the increase in injection.

 A decrease in any injection will decrease national

income by more than the initial decrease.
 MONETARISM

 This theory differs from Keynesianism as this believes

that the main determinant of national income is
aggregate supply not aggregate demand.

 They believe that it is the quantity of resources

available and how productive they are.
 Keynesians believe that demand creates supply

 Monetarists believe that supply creates demand.

 QUANTITY AND EFFICIENCY

 Monetarists believe that an economy can increase

the quantity and efficiency of its resources if it has
the following characteristics.

1. Private enterprise – having competitive markets,

with little government involvement. Producers will
be profit driven.
2. Low taxes on incomes – having high taxes does not
encourage firms to earn high profits and
discourages workers from earning high incomes.

3. A flexible labour market – it should be easy for

firms to change level of wages and staffing
dependent on demand. There should be low
unemployment benefit.
4. Governments should keep regulations to a
minimum – this is very important if it would add to
the costs of a firm.

5. Governments should concentrate its efforts on

improving the quality and efficiency of the
workforce through training and education.
TRADE CYCLES
 Every economy will see income and employment
fluctuate regularly over time.

 These fluctuations are called BUSINESS CYCLES or

TRADE CYCLES.

 An economy can be experiencing one of four cycles.

1. PEAK OR BOOM

 The following would be experienced:

 High income and employment

 Wages and profits will be increasing
 Consumption and investment spending will be high
 There will be inflationary pressure
 Demand for imports will be high
 Tax revenues will be high
2. RECESSION

 A recession is said to exist when there has been 2

successive quarters of negative growth in real GDP.

 This means that real GDP is falling.

 Following things may happen:

 Income and employment will fall. Although

unemployment is a “lagging indicator”.
 Wage demands are moderate
 Consumption and investment spending falls
 Inflationary pressures are moderate
 Tax revenues begin to fall and government spending
increases. (BENEFITS)
3. SLUMP

 This is when economic activity is low compared to surrounding years.

 These things happen:

 Mass unemployment
 Consumption and investment are low
 Few inflationary pressures
 Demand for imports are low
 Tax revenues are low and large demand for state benefits.
4. RECOVERY

 Income, output and employment begin to increase.

 Consumption and investment rise
 Inflationary pressures mount as workers feel more
confident about asking for increases
 Import spending rises
 Tax revenues start to rise and spending on benefits
falls.
PRICE INDEX
 What is Price Index?

 A Price Index describes the price of an item

compared to a base value measured at a particular
time or in a particular place.

 Price indices help citizens, industries and

businesses follow and predict trends in pricing.
 Consumer Price Index (CPI)

 The CPI is a measure of the change in price of

common household items - Calculated by
determining the average cost of 600 popular
goods and services.

 The average annual percentage change in the CPI is

a measure of inflation.
Types of Consumer Price Index (CPI)

 Consumer Price Index for All Urban Consumers (CPI-U)

- represents 93% of the population not living in remote rural areas. It
doesn't cover spending by people living in farm households, institutions, or on
military bases. CPI-U is the basis of the widely reported CPI numbers that matter to
financial markets.

 Consumer Price Index for Urban Wage Earners and Clerical Workers
(CPI-W)
- covers 29% of the population living in households with income derived
predominantly from clerical employment or jobs with an hourly wage. CPI-W is
used to adjust Social Security payments as well as other federal benefits and
pensions for changes in the cost of living.
Consumer Price Index (CPI) Trends
Consumer Price Index (CPI) Weights

 Different items
account for
different
percentages of
the CPI.
Interpreting the CPI
Activity #3