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By Maria K
NATIONAL INCOME
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Definition

 This is the monetary sum of the flow of goods and services in an economy per period of
time usually a year

By Maria K
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EXPRESSIONS OF NATIONAL INCOME

 a) Gross Domestic Product (GDP): This is the total value of goods and services
produced within a country's borders in a given period of time usually a year.
 GDP = C + I + G
 Where C: the household sector
I: The business sector
G: The government sector

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b) Gross National Product (GNP): This is the total monetary value of goods and services produced by
nationals irrespective of where they are located excluding output by foreign nationals in the domestic economy
(net factor earnings from abroad). The GNP equals the Gross Domestic Product plus income earned by domestic
residents through foreign investments (X) minus the income earned by foreign investors in the domestic market
(M). The (X – M) is also called the net foreign sector earnings, measured as the difference between a nation’s
value of exports and imports.
GNP = C+I+G+X-M
GNP = GDP + Net factor earnings from abroad
 

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c) Net National Product (NNP)

 This refers to Gross National Product minus depreciation i.e. GNP – Depreciation. NNP
is a better proxy for estimating national income.

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DEFINITIONS OF OTHER CONCEPTS

 Disposable Income (Yd)

It is the amount of income available for an individual or household to spend after Tax plus
Transfer payments.
Yd = Y – T+ TR
Yd = Disposable income
Y = Gross income
 T = Taxes
 TR = Transfer payments that is, incomes from friends and relatives

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MEASUREMENT OF NATIONAL
INCOME

i) The Factor Income Method (Income Approach)

Under this approach, national income is calculated by adding up all the incomes accruing to
basic factors of production used in production of goods and services. The income method
records all the incomes received by each sector as a result of transactions that take place over
the period of time under consideration. This will include incomes received as wages and
salaries of employees and the self employed, money earned by corporations, money received
by the government from its activities, interest payments received, payments from rent and so
on.
i.e. NY = Rent + Wages + Interest + Profit in respect of the four sectors of the economy.
Therefore, NY= C+I+G+X-M. All transfer payments are excluded in national income
measurement to avoid double counting for example, gratuity and pocket money.

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ii) The Expenditure Method

This is also known as the final product method. It measures national income at the final
expenditure stages. Expenditures include all money spent on goods and services at market
prices. These expenditures are computed and added to obtain the total value of products
finally sold. Hence, the expenditure approach involves aggregation of the household sector
expenditure (consumption), business firms’ expenditure (investment), government
expenditure (provision of social services) including net expenditure in the foreign sector (X-
M).

NE=C+I+G+X–M

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iii) The Value Added Approach/ the output method

 All goods and services have a price. That price represents the value of the inputs that went
into the production of that item - land, labour, capital and enterprise. At each stage of the
production process therefore, the value of the output carried out can be recorded - this is
the value added.
 We add the net value added at different stages in production of goods and services in an
economy per period of time. It is difficult to trace the intermediate stages under this
approach. The total value added is the price at which the commodity is sold .To avoid
double counting, it is only the net value that is added and not the intermediate values

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 Note: The three methods must yield the same results because the value of the goods and
services produced (O) must be equal to the total income paid to the factors that produced
these goods and services (Y) and the income paid to factors of production must equal to
total expenditures on goods and services (E)
Hence, O =Y=E

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Problems of Measuring National Income.

 Definition. Definitions try to exclude certain incomes, certain groups of incomes such as
gifts, pocket money to students, unemployment benefits etc. This problem is practical
when we are using the income approach.
 Double Income. This may be caused by the life span of the commodity or it may be due
to difficulties in differentiating between intermediate goods and the final goods. This is
applicable to value added approach to avoid this we only consider the market value of the
final product, and neglect the intermediate stages.

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 Errors of Omission. Due to insufficient statistical data, these errors are committed. Many
activities in LDCs are not marketed especially in the rural areas, activities such as work
done by house wives, leisure forgone, output for subsistence etc.
 Errors of Commission. There are some activities which are ignored due to their negative
contribution to national income figures such as pollution. The resource exploitation rate is
usually not included in National Income statistics. Resources and Environmental
economists are pushing for these issues to be included in the accounts procedure.
Therefore the rate of depreciation of natural resources should be included.
 Some transactions are not properly recorded because they are informal in nature. E.g.
gambling and prostitution.

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 Large subsistence sector (barter exchange)k

 It is a very expensive venture (inadequate funds)
 Inflation of changes in the prices.
 Inadequate qualified personnel (statisticians , economists, etc)

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Importance of National Income

 Used for policy analysis for example, policy on inflation, unemployment, exports and
imports.
 For comparison purposes in respect of economic performance between two periods in
time.
 For purposes of estimating Per-Capita Income
 The information helps us to show the distribution of income among different sectors of
the economy for example, the Household Sector, the Business Sector, government etc

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 For budgeting purposes, allocation of resources to different sectors

 Comparison in standard of living over time
 Comparison of standard of living between two countries
 To compare sector contribution to national economy.

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NATIONAL INCOME AND WELFARE

 Per-capita income refers to income per head of a given population.

It is denoted as Total National Income
Total Population
 It may be used to determine the standard of living (welfare) of a given population

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Limitations of Using Per-Capita Income as a
Measure of Standards of Living

 Doesn’t take into account the type of goods produced. Some goods do not directly
improve on human welfare but increase national income and hence per capita income.
 Per Capita Income takes no account of the inputs used to produce the output. For
example, if everyone worked for twice the number of hours, then GNP might roughly
double, but this does not necessarily mean that workers are better off as they would have
less leisure time. Similarly, the impact of economic activity on the environment is not
directly taken into account in calculating GNP.
 Movements in exchange rates may distort comparison of Per Capita Income from one
country to another.

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 Per Capita Income does not take into account many factors that may be important to
quality of life, such as the quality of the environment and security from crime, This can
lead to distortions - for example, spending on cleaning oil spill is included in GDP, but the
negative impact of the spill on well-being are not taken into account.
 The per-capita income statistics does not consider income distribution. Some times total
national income or population may be wrongly estimated.
 Doesn’t consider the cost of living (prices for goods and services).
 Inflationary tendencies make comparison in standard of living very difficult

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SECTORS OF AN ECONOMY

 The aggregate sectors of the macro economy reflect key macroeconomic functions.
 There are four aggregate macroeconomic sectors that form the foundation for
macroeconomic analysis; the household sector, the business sector, government sector,
and foreign sector

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1. Consumer sector or Household Sector (C): The role of this sector includes the supply of
labour services to other factors of production and also the payment of taxes to the government
for the provision of services. The excess income (Disposable) is spent on consumer goods.
2. Business Sector (I): This sector includes all production units and aims at profit
maximisation. The role of the business sector include; the provision of goods and services and
the payment of taxes to the government.

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3. Government Sector (G): The role of the government includes taxation and transfer
payments. This function is known as distributive function. The provision of goods and
services especially those that cannot be provided by the private sector such as National
Defense, police etc is known as allocative function. The stabilisation function where the
government tries to influence the level of economic activities by making use of fiscal and
monetary policies. In this function, government is meant also to stabilise prices, exchange
rate, employment etc
4. External or Foreign Sector (x-m): This comes in through international trade and
international capital flow. It includes both exports and imports. In this sector, we analyse what
determines the gap between exports and imports. This is commonly known as the trade
balance.

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TWO SECTOR MODEL

 This consists of household and business sectors.

Assumptions
 The business sector is the sole supplier of goods and services, it does not retain any of its
output and also depends on the household sector for the supply of factors of production
 The only source of income for the household sector is through the sale of factors of
production and it spends all the entire income received from the sale of factors of
production.

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Payment for goods and services

Services of FOP ( land, labour, capital and entreprenuership)

HOUSEHOLD BUSINESS
hh
SECTOR SECTOR

Payments for FOP (Rent, wage, interest and profits)

By Maria K
Flow of goods and services
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Determination of Equilibrium Output.

 The level of output is determined by the forces of demand and supply also known as
market forces. From the above model, the amount of money received by the households
must be equal to the amount of money spent by the business and when we put all the
assumptions into consideration, then

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THREE SECTOR MODEL

 Here, we present a closed model and it’s presented by a closed economy circular flow of
income. The sectors here include; Household, Business and Government.

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Payment of services of FOP

Direct taxes on income

GOVERNMENT
SECTOR

HOUSEHOLDS Indirect taxes e.g VAT

Government Expenditure BUSINESS
ECTOR SECTOR
Consumption spending (C)
Household savings (S) = Investment Spending(I)
Direct taxes on business

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FOUR SECTOR MODEL

 This adds international transactions to a three sector model. Goods and services available
for purchase include those that are domestically produced and automatically those that
come from outside the country.
 Expenditures on the domestic economy and foreign made goods include C, I, G and X
therefore the national Income identity is

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AGGREGATE SPENDING (DEMAND)
APPROACH

 Assume at existing price level, Aggregate Demand (AD) is less than AS, there is a surplus
output when production is determined by the Aggregate Supply (AS) curve. Here the
business sector production is determined by AD; i.e. business produce what is sold at
current prices. The different behaviour is assumed for individuals and businesses; (I)
investment is unrelated to output and is therefore exogenous; consumption spending (C) is
a positive function of current disposable income (Yd). Because consumer savings equals
current disposable income less consumption.
 , savings is a positive linear function of Yd and that Yd equals the value of output (Y)
since there is no Government sector.
 

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C=a+bY

The consumption curve

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 The quantitative approach

At equilibrium,
 AD = AS……………………....(i)
 But AD = C + I……………………(ii)
 AS = Y………………………..(iii)
 Substituting iii and ii into I
 C + I = Y……………………..(iv)
 But C = a +bY…………………….(v)
 I = IO ……………………… (vi)
 Substituting v and vi into iv
 a +bY +Io = Y ……………...(vii)

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 Collecting like terms

a +Io = Y - bY …………... (viii)
a +Io = Y (1- b) …………... (ix)
1-b 1-b
Y = a +Io…………………… (x)
1-b
where a = autonomous consumption expenditure
Io = autonomous investment expenditure
b = the marginal propensity to consume (MPC)

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MULTIPLIERS

 Is the number of times a change in autonomous expenditure multiplies itself to generate a

given level of national output/income in other words, it measures how national o/p
changes due to a given change in autonomous spending.

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Multipliers in a two sector economy

 In a two sector model, we have the investment multiplier. It refers to the number of times
investment expenditure multiplies itself to generate a given level of income
 Illustration
 Y=a+I0/1-b
 Y+∆Y = a+I0 +∆I)/ 1-b
 Eqn2 – Eqn1
 ∆Y= ∆I/1-b
 Dividing thru by ∆I
 ∆Y/∆I = 1/1-b

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 Note: an investment multiplier is positive and this is because an increase in investment

expenditure leads to an increase in national income
E.g. C=200+ 0.8Y, I=250
 Determine the investment multiplier
 The APC and APS
 The MPC and MPS
 The new equilibrium level of income if investment expenditure increases to 300 units

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Multipliers in a three sector Economy

 There are four common measures of multipliers in a three sector model i.e. investment
multiplier, government multiplier, tax multiplier and transfer payments multiplier
 Y= C+I+G
 C= a+ bYd
 Yd= Y-T+TR
 T= T0+tY

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Definitions, derivation and sample questions

 the investment multiplier:
 the Government Multiplier- the number of times that government expenditure multiplies
itself to generate a given level of income
 the Tax multiplier- number of times that tax multiplies itself to generate a given level of
income-(reduce taxes to stimulate consumption and expenditure thus increase national
income)
 the transfer payments multiplier

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Multipliers in a four sector economy

There are five common measures of multipliers in a three sector model i.e. investment
multiplier, government multiplier, tax multiplier and transfer payments multiplier, the foreign
trade multiplier
 Y= C+I+G+(X-M)
 C=a+bYd
 Yd= Y-T+TR
 T=T0+Ty
 M= M0+mY

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 Definitions, derivation and sample questions

 Consumptions and Savings
 Defn, determinants

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 Examples
 Given that the expenditure on C is 40% of income and the investment levels are U shs 10 billion.
Find the level of equilibrium output.
  

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 Given that the consumption expenditure is 80% of income and the level of investment is Ug shs
is 20 million. Find the equilibrium level of output.
 Given that the amount of investment that firms wish to spend is $ 22,000,000 and the
consumption function is in million of US dollars.
 Given that. Find the equilibrium level of output of that economy.

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 Suppose and the level of. In the absence of a Government sector and taxes, the value of output
equals Household disposable income so that
 Suppose Savings. Thus, the savings function will be by, why?
 Given that. Find the equilibrium level of output of the economy

By Maria K