Assaignment topics:

Nature , conceps , measurement of nation income

Classical and Keynes approaches

nATIONAL INCOM E:
----The t otal sum of goods and services produced by t he people of a count ry wit h t he help of capit als and national
resources called Nat ional Income (Prof. Alfred Marshall)
We can define Nat ional Income as t he collective achievement of a nat ion. In t his way, t he Nat ional Income is t he
aggregat e of t he individual incomes. (Prof. Gardner Ackley)
Nat ional Income is t he basic concept of economic, which refers t o t he market value of t he goods and services
produced during a part icular year. (Prof. Richard Lipsy)

CONCEPTS OF NATIONAL
INCOme

----1.GROSS DOMESTIC PRODUct

Total value of output (goods and services) produced by the factors of production located within the
country’s boundary in a year

GDP = GNP – Net income earned from abroad

2.GROSS NATIONAL PRODUCT

Defined as current value of all goods and services

produced by the economy during a given period
•
GNP = value of all (final) goods and services produced in a country in one year + income earned by its
citizens abroad - income earned by foreigners in the country

3.NET NATIONAL PRODUCT

Net National Product (NNP) is arrived at by making some adjustment, with regard
to depreciation, in GNP

GNP – Depreciation = NNP

4.PERSONAL INCOME
Current income received by the individuals or households from all sources including transfer income from
government and business during the year

Personal income = net national income + transfer payments – undivided corporate profit – corporate
income tax – social security contribution
5.DISPOSABLE PERSONAL INCOme

Actual income which can be spent on consumption by individuals and families 

Disposable income = consumption expenditure + Savings

CORPORATE INCOMe
Incomes and profits of companies or public corporation

DOMESTIC INCOME
Income generated by the factors of production within the country from its own resources

PER CAPITA INCOME

Average earning of an individual in a particular year
Per capita income = national income of a country/population of a country

REAL INCOME

National income expressed in terms of level of prices of a particular year taken as base

Real NNP = NNP for current year * base year index / current year index

12) Measurement of national income in an economy is very important because it gives an

estimation of the welfare of the economy. National income is the total of the value of the goods
and the services which are produced in an economy. The basic measures of national income
include GDP, GNP, GNI, NNP and NNI. There are three approaches through which national
income can be calculated including; output approach, income approach and expenditure
approach. All of these approaches give the same value of the national income.

The method for calculating National Income by Output, Value Added method:
GDP at market price = Value of Output in a year - Intermediate consumption
NNP at factor cost = GDP at market price - Depreciation + NFIA (Net Factor Income from Abroad)
- Net Indirect Taxes
The measurement of National Income by Income Method:
NDP at factor cost = compensation of employee + operating surplus + Mixed income of self
employee
National Income = NDP at factor cost + NFIA (net factor income from abroad)
The measurement of National Income by Expenditure Method:
GDP = C + I + G + (X - M)
Where:
C = Personal consumption expenditures
I = Gross investment
G = Government consumption
X = Gross exports
M = Gross imports
There are three methods which are commonly used for the measurement of national
income. These methods include output value added method, income method and
expenditure method.
National Income by Output, Value Added method:
GDP = Value of Output yearly - Intermediate consumption
NNP @ factor cost = GDP at market price - Depreciation + NFIA - Net Indirect Taxes
National Income by Income Method:
NDP @ factor cost = compensation of employee + operating surplus + Mixed income of
self employee
National Income = NDP + NFIA
National Income by Expenditure Method:
GDP = C + I + G + (X - M)

CLASSICS AND KEYNES

TWO VIEWS OF THE ECONOMY

Macroeconomics is the study of economics from an overall point of view. Instead
of looking so much at individual people and businesses and their economic
decisions, macroeconomics deals with the overall pattern of the economy. To star CLASSICAL ECONOMISTS-
with, we will look at two main groups of economists: the Classical Economists economists who believe in no
and the Keynesian Economists. Classical economists generally think that the government regulation of the
market, on its own, will be able to adjust while Keynesian economists believe that economy
the government must step in to solve problems. The two camps have differing
ideas on the causes and solutions of unemployment. The Classical economists KEYNESIAN ECONOMISTS-
believe that unemployment is caused by excess supply, which is caused by the economists who believe in
high price level of labor. Based on supply and demand, when wages are held too government regulation of the
high by social and political forces, demand would be low and supply would be economy
high and that excess supply represents unemployed people. Classical economists
believe that if the economy were left on its own, it would adjust to reach an
equilibrium wage for workers and the economy would be at full employment.

CLASSICAL ECONOMICS
Classical economists believe in Say's Law, which states that people supply things
to the economy so they have income to demand things of the value they've
supplied. Classical economists also argue that all money is always in the economy, SAY'S LAW-Law stating that
because even when people put their income away in the form of savings in banks, with supply naturally comes
stocks, etc. that money still flows back into the economy in the form of demand; there is never
investment. When savings money flows into banks, even though it does not oversupply
directly go to the industries in the form of purchases, banks loan this money to
industries to invest in further development. Investmen takes the form of money to INVESTMENT-Resources
acquire new machines, labor, facilities, etc. so that businesses grow. spent on the means of
production, so as to supply
products into an economy and
make a profit

MONEY-Something used to
value goods so that they may
be bought and sold

VELOCITY OF MONEY-The
number of times that a unit of
currency is spent each year
 VEIL OF MONEY
ASSUMPTION-Changes in
money supply do not affect real
production of goods and
services

Fig 2.1.1-Money flows from

business to individuals in the
form of paying jobs;
households then spend most of
it to buy products from
business; the part that is saved
in banks of the financial sector
Fig 2.1.1-Transfer of money is invested in business

Fig 2.1.2-If there is a

disequilibrium between supply
Crucial to the understanding of classical economics is an understanding of how and demand, the supply can
money works. Money is just something that can value goods, used to exchange never change. The price level
those goods among individuals in an economy. The quantity theory of money is simply moves until the demand
the theory dealing with money and prices. It states that the price level in an is equal to supply.
economy depends on how much money is in the economy. In classical economics,
the quantity theory of money centers around the equation "(Quantity of money) x
(velocity of money) = (price level) x (quantity of goods sold)." Velocity of money
just means how often money is spent. The price level times the quantity of goods
sold obviously equals the GDP, total production. Velocity, then, times the amount
of money would equal that. A coin, for example, is passed around from person to
person throughout time and each time it is spent, it generates income worth its
value. The number of times that coin was passed on throughout the year is its
velocity and that times its value gives how much production it represents that year.
When you add all the income generated by all the money out there, you get the
GDP also.

The velocity of this money depends on what the structure of an economy is like. It
depends on things like where people work, where they shop, how often they shop,
etc. Since no drastic economic restructuring could be expected to occur in any
short period of time, this velocity is assumed to remain constant from year to year.
(It does change, but this change is so incredibly slow as to be irrelevant.) Classical
economics also stresses that the amount of goods and services produced is not
affected by the money supply. This doctrine is the veil of money assumption.
This assumption separated the world of finance (of purely monetary studies) and
the rest of the economy (the production of goods and services). The veil of money
theory basically says that when the money supply changes, the real economy does
not because when money supply changes by a certain amount, everything else
does as well. If it doubles, then prices double, and people's pay doubles too to
compensate for this, so nothing really changes. Classical economics states that
money supply is the force that changes the price level.

Since money supply changes prices and money supply is not affected by
production, the amount of supply is independent of the price level. The amount of
output is chosen by people and, according to classical economics, as long as
they're no outside pressures intefering with the markets like politics, the amount of
supply will always be at full employment level. Demand in the long term is not a
problem because in the long term, based on Say's Law, supply generates its own
demand and so there will be long-term equilibrium. As stated earlier, classical
economists see the problem of unemployment as a self-solving problem like all
other things. Wages will fall and then demand for labor will increase and
eventually everyone who wants a job will get one.

The long-term classical model does not solve short term problems. In the short
term, there are always various fluctuations that move demand and supply out of
balance of each other. There must be a mechanism to equalize them again.

Fig 2.1.2-Classical adjustment model

Suppliers in the classical model never change how much they supply, they just
change their prices so that people will buy them. No matter what, supply is an
independent concept. Suppliers will always produce how much they want to
produce at a given time. Demand, however, can move by changes to the price level
so that all that is produced is actually bought.

KEYNESIAN ECONOMICS
A basic argument made by John Maynard Keynes, a famous economist during the
depression era who invented the idea of Keynesian economics, was that Say's law
was just plain false. In Keynes's analysis of the economy, he looked at the
problems of supply and demand separately. The problem of supply is relatively
simple: supply generates income. What people make are bought, and thus the
value of supply is always equal to the value of income. This income is then passed
on to the consumers in the form of paychecks. The consumers then spend this
money to buy various products. Keynesian economics have several concepts to
explain how consumers spend their income.

The money that people get are always split between consumption and savings.
People who have enough money usually save some of it and spend most of it.
There are two ratios Keynesian economics considers when dealing with
consumption: the APC and the MPC. The APC, average propensity to consume, is
a ratio telling us how much of people's income they tend to spend. The APC varies
with income level. The MPC tells us what part of a change in income people tend
to spend. For example, if the MPC was .5 and somebody got an increase of income
of $1000, then they will spend $500 dollars of that increased income. Conversely,
people will cut their spending by that ratio when they lose some income.

FIG 2.1.3-Based on Keynes's

ideas, production and spending can be represented by two different curves. The
two different curves meet at a point of equilibrium. If they are different, then
production is adjusted until equilibrium is reached.

Fig 2.1.3-Keynesian consumption function

In this graph, we can see a graphical representation of Keynes's ideas. The blue
line represents production. The red line represents how much people spend. The
slope of the line, or how much the line goes upward for every increment
horizontally, is the MPC, which in this case is 0.75 (how much of every extra
piece of income is spent). The slope of the production line is 1 since production =
income. When income is way too low, as shown in this, spending must exceed
income because no matter what, there are some things that people must buy, like
food. They do this through borrowing and dipping into savings, etc. Beyond a
certain point, people have enough to save some of that money. APC can be
represented on this graph as the ratio of the amount represented by the red line to
the amount represented by the blue line at any point. Notice that this ratio changes,
which makes sense in the context of Keynesian economics. At the point where
spending equals production/income, the APC is 1 and at that point, people spend
all the money they make.

Of course, the rest of the money, the money that is not spent, goes into savings.
There is also APS and MPS, the average propensity to save and marginal
propensity to save. APS is what part of income people save and MPS is what part
of additional income people save. APS+APC=1 and MPS+MPC=1, as savings and
spending together equal income. Savings is the part of the graph between the two
lines. When spending is more than income, people save, savings represented by
the difference between income and spending. When spending is more than income,
people take money out of past savings, the amount represented by the difference
between spending and income. Another component of Keynes's analysis was the
independence of investment. Unlike classical economics, which states that all
savings go into investment, Keynes said that how much people invests is simply
how much they feel like investing. There are more complicated models, but to
keep this simple now, investment is not changed by savings or income. To keep
the model simple, we will assume that government spending and foreign trade is
all independent. If you add all these factors into the spending, the red line
representing total spending would be shifted upwards (the whole line, the slope is
still the same).

Whenever the economy is not in equilibrium, firms change their production until
equilibrium is reached. When there is more production than expenditure, there is
an excess of supply, as firms are not selling everything they produce. Thus, they
have to decrease production until production equals consumption on the graph. On
the other hand, if there is too little supply, the portion of the graph where
production is less than consumption, firms increase their production to meet the
demands of customers until the two lines of output and spending meet at
equilibrium. The economy is continually adjusting in the Keynesian model as
various factors influence the independent factors of investment, government
spending, and net export, factors outside of income and production. Interest rate
changes, future predictions, and technology can affect investment. Government
spending may change depending on varying political situations. Net export, too,
can change with a nation's changing international position. These changes can
move the spending curve up or down (again, shift as opposed to changing the
slope) and thus force further adjustment of production. With his model, he
explained the Great Depression: after the crash of 1929, people became scared.
Invetment was cut as was spending. When this happened, companies decreased
their production even more as spending decreased and this was followed by a drop
of spending as income fell (income=production). This drop continued until
equilibrium was reached at a point that is way below that of full employment.