National Income Determination - Term Paper Example

National Income determination Introduction The most well known indicator of the quantity of goods and services which people can enjoy is the nationalincome. It is the measure of output. Famous economist J.M. Keynes defined it as "national income is the money value of all goods and services produced in the country during a year". National income shows the economic position of a nation; every economy wants to achieve progress which is achieved by the coordination of human resource, natural resource, capital, technology etc. National income helps in assessing and comparing the progress achieved by the country over the period of time. Two common measures of income are GNP (gross national product) and GDP (gross domestic product). GDP measures the total value of output (goods and services) produced by the factors of production located within the country's boundary in a year. The factors production may be owned by any one - citizens or foreigners. GNP is the total value of output (goods and services) produced and income received in a year by domestic residents of a country. It includes profits earned from capital invested abroad. While taking them both together we get, GNP=GDP+ net property income from abroad (NPIA) Economically speaking when the demand for commodity goes up; the production increases. Income leads to expenditure which again leads to production. Thus production, income and expenditure are mutually related; economic activities are related to these 3 stage. Based on this 3 methods are used to calculate national income 1. Production method 2. Income method 3. Expenditure method. Importance of National Income and Problems of Measurement National income's measurement is necessary for a country due to various purposes; it helps in projection of future course of economy, estimates economic development and how far have they been achieved, helps government to design suitable development policies, helps firms in forecasting the future demand of their product, tells the contribution of various sectors to national income and facilitates international comparison. Various problems rise while measuring national income. The first problem is of valuation, there are vast range of goods and services whose values cannot be added together in physical units. For e.g. we can not add kilograms of wheat, to meters of cloth, to tones of coal in physical terms. (G.F. Stanlake, 1995). Thus the only common measure is money. Secondly when goods and services have no market price values difficulties are encountered like in public services such as defense, law and order, education and health services. The solution adopted is to measure their values at cost. Then there are problems with the goods and services which people provide for themselves like farmers consume some of their own output or much of repair and improvement work is done by 'do it yourself' basis. Rough estimates are used in these cases in measuring national income. Double counting is yet other problem as the output of one firm are the inputs of other firm; two ways to tackle this is either by adding value of final product or totaling the values added at every stage of production. National output is measured at times in terms of factor cost, using market prices could be misleading this is another problem associated with measurement of national income. Measuring national income Three different methods are used based on different views of national income. Firstly the production method in which national income is viewed as the total output from domestically owned resources during the course of year. This is the most direct method where the output figures of all the firms in the country are taken. Exports are included but imported materials and services are excluded (this is automatically done as values added in the country are taken). This will give us GDP and to it add NPIA. Income method the second approach is viewed in terms of incomes earned by factors of production engaged in producing the national output. As the total product is valued at factor cost, it must be exactly as same as total value of income (wages, interest, rent and profits) which have been paid out to factors of production. National income is then measure by totaling these incomes. All personal incomes are not included in the national income. Thirdly national income is viewed from the point of view of disposal; the expenditure method. National output is either bought for use or added to stocks, national income is measured by the amount of money spent on purchasing the national output, only the final expenditures are noted, all the intermediate ones are excluded. The total expenditure is divided into consumption, government spending, investment, imports and exports. Then the analysis is made. Thus concluding Natural output =national income =national expenditure Changes in the national income are often used to indicate the standard of living. These figures measure the material standard of living rather then the quality of life, which is only effected by them. Model of national income determination The circular flow of income is explained with the simplest model, which consists of business (firms or producers) and public (household or consumers). The firm is involved in doing investments, government spending and exports while the household is responsible for savings, pay taxes and utilizing imports. The firm generates the income by producing factors of production while the household consumes it paying its value. The national output or national income is in equilibrium when total planned expenditure is equal to the output that is actually produced. Total expenditure consist of consumer spending on goods and services (C), investment spending by firm (I), government spending on goods and services (G) and exports (X) i.e. spending by overseas residents on the national outputs. To find out the amount spend on national output we deduct the value of imports (M) from spending in the home market. Thus this gives us total planned spending on the national output which is equals to national income (Y). Y=C+I+G+X-M Another way to look at it is by looking at leakages and injections. Leakages are the income in the circular flow which is paid out by firms and not returned to them through spending of house holds; this includes the savings, taxes and imports. While injections are those that cause output and income to expand, they provide additions in the circular flow. Injections include investment, government spending and exports. Thus looking at the circular flow total planned injections is equal to total planed leakages so we can say that in equilibrium I+G+X=S+T+M Conclusion The national income although one of the most important components to measure for a country; at times comprises of errors and omits the important contributors to economic well being including leisure, amenities and household production. The national income may not always be a true indicator of quality of life and average standard of living, at times it may mislead. The average standard of living may not be a decisive factor in judging a nation's economic performance. The two important contributors of national income are GNP and GDP which have their effects on the total figure. Looking at the national income figure of US in 1998 was $7063.4 billions (Department of Commerce, Bureau of Economic Analysis, Economic Report of the President, February 2000), which was greater as compared to many other countries. The three methods used to determine the national income have all their distinct features and are used according to the circumstances. Production method is used when output figures are given, income method is used when income earned by factors of production are known and the third expenditure method in case final expenditures are noted. The final sum of all the methods is equal no matter which one is used. The main components in determining the circular flow of national income are the households and the firms. We people come under the household and have the consumption power while the firms around have provide income to households. All this is interlinked and related to each other. Outline This article is concerned with the national income and its determination. Firstly I have highlighted the introduction to national income and its importance of calculation for the country, and then the problems associated with the calculation. The main subject of the article which covers the 3 ways of calculating the national income is then dealt with and individually their methods are discussed. The article finally concludes with the information on the standard model which defines the flow of income in the nations. And finally the derived equation for national income is explained. This matter concludes the article. Work cited David Flath, The Japanese Economy, 2nd edition, Oxford University press 2005. GF Stanlake and SJ Grant, Introductory Economics 6th edition, National Income determination, Longman publishers. National Income, www.education.kerala.gov.in/englishmedium/geographyeng/chapter11.pdf Read More