LESSON – 19NATIONAL
INCOME - 1Circular Flow and Measurement of National Income
Learning outcomes
After studying this unit, you should be able to:
Understand national income
Importance of national income
Define national income accounting
Analyze the circular flow of income
Discover the flow of income in various sectors
Understand different sectors
A. CIRCULAR FLOWS OF INCOME
We have already explained that national income is a flow. This flow can be expressed either interms of goods and services or in the form of money income. The flow is also known as the realflow. The flow of money income is known as the money flow.
Flow of Income in a Two-sector Economy
We will explain the flow of income in an economy by taking a model of simple economy in whichonly two sectors operate viz., household sector and producer's sector or firms, Real flow andmoney flow of income are shown in Figure. The upper loop in Figure shows the real flow in theeconomy. Households supply factor services to the firms'. Business firms by utilising the factor services produce goods and services. Firms provide goods and service_ to households as areward of their factor services, i.e., goods and services flow from firms to households; thisconstitutes the real flow in the economy.Figure of flow of incomeIn the modern economies factor payments are not made in kind hilt in terms of money. Factor-owners, i.e., households, receive their rewards in the form of money, as shown in the lower loopin Fig. 7.1. household utilizes this money to purchase goods and services produced by the firms.Thus money flows from firms to households and again back to the firms. Since the income flow ina circular way between the firms and households, this flow is also known as “Circular flow of income”.
Inclusion of Saving and Investment in the Flow of Income
The above simplified illustration of the circular flow of income has been based on a fewassumptions, viz.,(a) whatever income the households receive, the whole of it is spent on consumptionexpenditure, and(b) whatever income the firms get by selling goods and services, the whole of it is spent inmaking factor payments.In real life, however, households and firms save a part of their earnings. These savings arepooled together in: the capital market. Capital market refers to those institutions which transact inloan able funds; such as banks insurance companies, etc. Savings accumulated in the capitalmarket are utilized by firms for investment purposes, as shown in Figure. Thus, the circular flowof income goes on, moving continuously with no disruption. Saving comes back to the economyin the form of investment. In the ultimate analysis, savings and amount of investment in aneconomy will always be equal.Figure
Government Sector and the Flow of Income
Government plays a significant role in the economic life of any country. Government acts both asa consumer and a producer in the modern economies. It has its own sources of income, and alsoit has to incur expenditure in a number of ways. A government collects taxes both from the firmsand the households. A tax is a compulsory payment levied by any authority without any regard tothe service rendered by it. Tax is the major source of income of modern governments. Agovernment spends the income so accumulated on a number of activities, which are so designedas to benefit both the households and the firms.For example, government may undertake to operate a number of collective services for the use of the community. This type of activity will satisfy the communal needs of the society. Likewise, it isalso possible that the government may incur expenditure to render some services to the firm-sector ;e.g..the Government may decide to subsidise the production of a' few importantcommodities.' Similarly, govenment may purchase goods and services from the firm-sector for thecollective use of the society. With the introduction of the government sect<;>r, the circular I flow'of income will look like as in the givrn Figure. .
Figure of government sector flow of incomeIt is clear from the above Figure that whatever the government takes out from the flow of income,it pumps back the same in the form of public or State expenditure, and thus, the circular flow of income goes on moving continuously.ACTIVITYGive some examples of government sectors--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Introduction of Foreign Trade
We can further' complicate our model of/the circular flow of income in an economy by includingyet another sector; this time we will consider the effect of foreign trade on the circular flow.Foreign trade is the characteristic feature of the modern open economies. Foreign 'trade impliestwo transactions, viz., exports and imports. Goods and services are exported from one country toanother, and similarly imports also come to a country from different sources. Firms andgovernment receive money value in the form of payments for exports, and make paymentsabroad for imports, as can be seen from Figure.Thus, a part of income which is sent abroad towards payments for imports comes back to the flowin the form of receipts for exports.To sum up, income is generated in the producing sector of the economy; it flows between thedifferent sectors making, the productive process a continuous activity. This size of the flow will-vary depending upon the fact whether the economy is a growing or a static one. In a growingeconomy, level of economic activity will go on increasing, made possible by investment, which -represents a surplus of production over current consumption. As investment increases ,productive potential of the economy will increase, resulting in more production and higher, con-sumption, and also more saving. Government transactions will- also increase, as its revenue fromsources like direct and indirect taxes will go up ;similarly, it will be called upon to perform morefunctions necessitating higher expenditure. Likewise, the 'economy's'externaj.tratlsaClt0'nS may.:a 0 increase. But if we stick to our assumption that exports and imports balance in value, andthat the net receipts on account. of external transactions amount to zero,' these transactions willnot affect the size of the 'flow, at least not directly. although it may create conditions that lead tomore reduction in the economy, and thus set in a chain 'sequence which inflates the size of the
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