Chapter 3

National Income
-The Income of the Nation is measured by the total earnings of the factors of production
owned by the citizens or by the total market value market value of all final goods
and services produced by its citizens.

-Such earnings or market value of final goods and services are estimated on a yearly basis.
-Such measurements reflect the performance of the economy.
-These indicate whether the National Economy is progressing or regressing.

-For instance:
- If this year the National Income is bigger than that of last year, and that last
year’s National Income was bigger than that the previous years,
Then it can be said that the economic performance of the country has been
improving during the last few years.

-However, if is reverse situation, then the economy is regressing.

In fact, such declining National Income has been experienced by many poor
countries.

Variations (ups and downs) in National Income are the products of interactions between
and among several factors like :
1.) Population
2.) Investments
3.) Savings and Consumptions

For Example:
If investment is greater than savings, it means more economic activities.
There is an increase in employment, production and income.
Consequently, these increase consumption which stimulates further investments.
Such positive economic activities certainly raise the level of National Income or Gross
National Product (GNP).

However, it is not correct to say most of the time that an increase in GNP or PCI means an
improvement of the welfare of the people.
In a country where most of the productive resources belongs to very few families , Increase
in the National Income only benefits the few rich.

The Circular Flow of Income Model:

Circular flow – The continual circular movement of money and goods in the economy.

Household– Persons living under the same roof, whether they are related or not.
The household is an economic unit representing consumers and resource owners.

Business Firm – the basic unit engaged in business activity. It may be in the form of a
single proprietorship, partnership, corporation, or cooperative.

Government– the agency or instrumentality through which the will of the State is
formulated, expressed and realized.
The government may use its financial powers to influence the nation’s economy.
Ex. Fiscal Policy and Monetary Policy

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Rest of the world – refers to other countries of the world that engaged in international trade.

International Trade:
Export- a good or service that is sold by one country to another through foreign trade.
Import – a good or service which a particular country purchases from another country.

Transfer Payments – these are payments made to individuals which do not involve the
production of additional goods or services.
Examples: donations or gifts from relatives, foreign aid, or pension payments.

Market – an arrangement whereby buyers and sellers interact to determine the price and
quantities of commodities.

The Circular Flow of Goods and Income of Households and Firms with the
government and Foreign Countries.

(Rent, Wages) National Income (Interest, Profit)

(Land, Labor) Production Input (Capital, Entrepreneurship)

Indirect Taxes Direct Taxes

Productive Government Household
Enterprises
Subsidies Transfers Payments

Government Expenditures
(National expenditures)
Investment Expenditures

National Product (National Expenditures)

Market
Revenue/Receipts Household expenditures
(National expenditures)

Exports Imports

Rest of the World

Lesson 1 : The Gross National Product (GNP)

Definition of Terms:
Gross National Product – (GNP) – is the total market value of all final goods and services
produced by citizens in one year.

National Income– is the total Income of the factors of production in one year or the
total payments received by citizens in one year.

(note: GNP has a greater value than National Income because the latter is equivalent to
total cost of production.)

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Per Capita Income – (PCI) – is income per head.

Formula: PCI = National Income

Population

Per Capita GNP = Gross National Product

Population.

Gross Domestic Product – is the total market value of all final goods and services produced
within the territories of a country in one year.

Incomes derived from investments or wealth in foreign countries

are excluded.

In the case of GNP,

The incomes of the citizens earned from abroad are included.

In a country whose economy is dominated by Multinational Corporations .

The GDP is bigger than GNP.

This is the actual situation in many less developed countries.

Real GNP – is the value of GNP in terms of the number of goods and services produced.
Money GNP – is the value of GNP at current price or market price.

Final Goods and Services – are those which are sold for the last time, and these are not
for further processing or manufacturing.
Example is bread.
-Flour is not a final product. It is used for making bread. It is referred
as intermediate product

Disposable Income – is personal income less personal taxes.

Ways of calculating National Income:

Income Approach:
Wages
+ Rents
+ Interest
+ Profits
= National Income
+ Indirect Taxes less Subsidies
+ Depreciation
= GNP

Product or Expenditure Approach:

Household Consumption Expenditures
+ Government purchases of goods and services
+ Gross Domestic Investment of Business firms
+ Net Exports(if the value of imports is greater than exports, it is minus)
= Gross National Product
- Capital Consumption Allowances (depreciation)
= Net National Product
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 Net National Product
- Indirect Business Taxes
= National Income

Industrial Origin Approach:

Agriculture , Fishery and forestry
Industry:
Mining
Manufacturing
Construction
Electricity, gas and water
+ Service Sectors:
Transportation
Trade
Finance
Service
= Gross Domestic Product
- Factor Income from the rest of the world
= Gross National Product
- Net Direct Taxes
- Depreciation
= National Income

Depreciation and Indirect Taxes

Depreciation –is an allowance for capital goods like machines which have been “consumed”
in the process of production.

A machine depreciates not only because of use through time but also as a result of
obsolescence or calamities like fire and flood.

Indirect Business Taxes – these include general sales taxes, excises, business property taxes,
license fees, and Customs duties.
The Businessmen pass on to the consumers the tax imposed by the government.

Note: To get National Income,

-Depreciation and Indirect Business Taxes are deducted from GNP which is the
market value of Final Goods.
-Because National Income is the factor value of Final Goods which refers
The Total Cost of Production or Factor Payments like Wages,
Rents, Interest and Profits.

Double Counting
The value of the goods and services must be counted only once.
To avoid double counting, only the value of the final goods and services are included.
The value of the Intermediate Goods which constitute the value of the final product is
excluded.
For example:
The market price of an executive table is P10,000.00 .
This reflected in the GNP as P10,000.00. The cost of the paint, plywood, nails,
lumber, labor, profit, and other costs that are incurred in the production
of the table are excluded. Otherwise, there is double counting. It would be
P20,000.00 which is not true.
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 Importance of GNP
GNP has several very useful functions such as
1.) Measurement of national economic performance
2.) A tool in both government and business planning
3.) A yardstick of economic growth of the different countries which is also the basis of
comparison.

Limitations of GNP
GNP has several limitations:
1.) It does not show the allocation of goods and services among the members of society .
It only shows the number of goods and services produced by citizens in a given
period.

An increase in GNP does not necessarily mean that the economic and social
welfare of the masses has improved.

In a society where there is a widespread maldistribution of wealth, an increase

in GNP only benefits the rich who own the productive resources.

2.) GNP accounting in less developed countries is understated .

There are many economic transactions especially in the rural areas which are
not registered in the market.
For Example:
Backyard Gardening, poultry, fishing and other small-scale income-
producing activities whose products are only intended for family
consumption.

Only market transaction are reflected in the GNP.

Evidently, there are many productive activities among the poor countries
which usually do not pass through the market system.

3.) The evils of economic growth like pollution, congestion and dirty environment are
not reflected in the GNP.
The cost of such destruction to the health of human beings, and to the balance of
nature is very high.

And this is not subtracted from the GNP.

The social price of economic growth such as broken families, drug addiction,
and other pervasive social crimes are not part of GNP.

What is only included is the expenditure of the government in fighting such

social disease.

4.) GNP only measure the number goods and services but not the quality of goods and
services.
Needless to say, quality is an important feature, It affects the well-being of the
people.

5.) Incomes or Products from illegal sources are not included in the GNP.
Examples are:
Gambling, prostitution, unlicensed money lending, and other narcotics business.
These industries have created not a few jobs and incomes for many people.
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 Consumption
Consumption – is the amount of money spent on goods and services which yield direct satisfaction.
(It is spending by households on goods and services)
(Goods – is a tangible item that provides satisfaction.)
(refers to intangible items needed by man)

Note: Consumption is considered as the biggest of the major components of

expenditure on output.
Example, When we purchase Car or a house, it is consumption.

Factors influencing Consumption

1.) Distribution of National Income
-Uneven Distribution of Income - - Income is largely concentrated in the
hands of a very small portion of the population.

Individuals with big Income are proportionately big savers.

-If there is a very Even Distribution - - the concentration of the bulk of

Aggregate Income is in the hands of individuals with moderate
Income.
This group does save much, as a result, Consumption tends to
be greater than savings.

2.) Rate of Interest

People tend to save more at a higher interest rate.

However, if Income earning assets (land/buildings) yield more Incomes,

Then, people are encouraged to purchase such assets.
Thus, savings decreases.

3.) The desire to hold Cash

Such needs for cash for personal or business reasons reduce consumption
and raises savings.

4.) Price Level

When prices are high (Inflation),
People spend more amount of money. This decreases Savings.

5.) Population
More people means more consumption.
More people haave to buy more goods and services.

6.) Income
Higher Income results to more consumption.

7.) Taxes
More taxes reduce disposable income.
This decreases consumption.

8.) Attitudes and Values

There are individuals who are thrifty or extravagant.
Evidently, these factors influence consumption or savings.
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 Investment
Investment – is the purchase of goods that will be used in the future to produce
more goods and services.

-In everyday parlance, investment also implies the purchase of assets which
are expected to bring about medium and long term benefit.

-It is the sum of purchases of capital equipment (such as machineries), inventories,

and structures (such as office buildings and factories).

However, the decision to invest is based largely on expected profits.

That is why our Government has granted a package of incentives to Foreign

Investors in areas in which Filipinos are not capable.

Determinants of Investment
1.) Marginal Efficiency of Investment (MEI) or Returns Of Investments (ROI).

2.) Interest Rate

High interest rate may discourage investments.
-If they obtained their funds from banks and they expect for low ROI,
They are reluctant to venture into business.

-If they have their own money,

They are more induced to save their resources in Financial
institutions rather than to put productive enterprises.

-There is still investment as long as ROI is much higher.

There are other factors which affect favorable the Marginal efficiency of
investment such as:

1.) Population - More people means demand or consumption of goods and services.
This stimulates further investment because there are many buyers.

2.) Price level - Producers are willing to supply more goods and services when prices
increase, and there is no increase in the cost of production.
This means higher return of investment.

3.) Technology – This reduces unit cost of production and improves quality of output.
Obviously this benefit both producers and consumers.
Lower cost of production encourages producers to produce more.

And if they offer their products at lower price, this increases the
demand for more units of output.

4.) Peace and Order - It certainly encourages investment.

There is always capital flight whenever the peace and order
situation gets worse.

Obviously, there is no investment during the war, revolution,

or rebellion - - except those who are selling arms.
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 5.) Government Policies - Fair monetary and Fiscal Policies attracts investments.

Monetary Policies on Banks credit and

Fiscal Policies on Taxation

These are effective tools in inviting more investments.

Multiplier and Accelerator effects in Investment

Multiplier – the chain of effects that are triggered off by an original change in an economic
variables.
In other words, Investments creates more income several times.
Example:
A Businessman builds a Factory Building.
It provides income to:
-Architect
-Contractor
-Suppliers of construction materials
-Laborers

These people in turn use their incomes to purchase other goods and services.
As other businesses are benefited, more money is spent on other goods and services.
The multiplier effect will be as effective as the amount of money spent by consumers
in relation to their disposable income.

Accelerator – the effect of consumption on investment.

More consumptions stimulates investments.
For instance, Many are buying shoes.
This encourages businessmen to put up shoe factories because the demand for such
goods is increasing.
When there is an increasing consumption level, it means good business.
And this is what investors like. They anticipate good profits.

Paradox of Thrift
Paradox of Thrift
An individual who saves contributes to the overall slack in business activity.
This Paradox was first brought up by John Maynard Keynes.

However, If savings are deposited in a bank, the bank uses them for productive
purposes by putting them back into the economy as loans.