An Explanation of the Measurement and Control of National Income

Definition National income is the total of all incomes earned by residents of a country who supply the factors of production in any given period of time. It is normally measured annually.

Methods Used to Measure National Income The expenditure method The production method The incomes method All three of these should equal each other as all money spent (expenditure) is spent on goods and services that are produced (production) and all incomes are earned from the production of goods and services.

This is known as the circular flow of income. Value of Production Value of production = Value of incomes = Value of expenditure Income for supplying the factors of production Households’ income Firms’ output Spending on the output of firms This is known as the circular flow of income.

Expenditure Method Calculate total expenditure, allowing for statistical discrepancy Plus value of exports Less value of imports = Gross Domestic Product (GDP) at current market prices Plus or minus net factor income with the rest of the world = Gross National Product (GNP) at current market prices Plus EU subsidies Less EU taxes = Gross National Income (GNI) at current market prices Less provision for depreciation = Net National Income (NNI) at current market prices Less Non EU taxes Plus Non EU subsidies = Net National Product (NNP) at factor cost

Incomes Method Calculate the total value of all incomes Less stock appreciation = Net Value Added at factor cost Add depreciation = Gross Value Added at factor cost Add non product taxes and Less non product subsidies = Gross Value Added at basic prices Add product taxes and Less product subsidies = Gross Domestic Product (GDP) at current market prices Less net factor income with the rest of the world = Gross National Product (GNP) at current market prices Add EU subsidies and Less EU taxes = Gross National Income (GNI) at current market prices (Proceed as per expenditure method to arrive at NNP at factor cost.) Less provision for depreciation = Net National Income (NNI) at current market prices Less Non EU taxes and Add Non EU subsidies = Net National Product (NNP) at factor cost

Production Method This method is not used by the CSO. This is an outline of the method that could be used. Calculate the total value of production Minus value of financial services = GDP at factor cost Plus or Minus changes in value of stocks of goods and Minus depreciation = NDP at factor cost Minus Net factor income with the rest of the world = NNP at factor cost

Y at Current Prices versus Constant Prices When comparing the national income statistics from one year to the next no allowance is made for the rate of inflation between these years as all goods produced / consumed are measured at the prices prevailing in the year in which the statistics were compiled, i.e. current prices. This can invalidate annual comparisons. A methodology used to overcome this difficulty is to measure each year’s figures at a constant price. This is done by taking a base year and taking all the prices of all the products to be produced at a value of 100. Then the change in prices in subsequent, or even previous, years are expressed as a percentage of the prices prevailing in the base year. Thus we succeed in comparing “like with like”.

Use Of National Income Statistics (As per the CSO) Used to measure growth from year to year. Used to compare Ireland’s national income with that of other countries. Used by policy makers, analysts and researchers to examine the performance of the economy. Used by the government for regional planning. Can be used to justify the demand for wage increases. Used for administrative purposes within the EU, e.g. taxes. Used in determining eligibility for EMU.

Limitations of Comparisons of Annual Y Statistics Measures growth not welfare. May be affected by population growth/ decline. Non market economic activities are not included. Changes in quality of goods not taken into account. “Bads” as well as “goods” are counted. Problem of inflation – measured at current prices rather than constant prices. Balance between the production of capital and consumer goods not highlighted. Leisure not taken into account – people may be working longer hours for the same income. Distribution of any increase in Y not highlighted. Difficult to account for the black economy.

Limitations on International Comparisons of National Y Statistics Common currency must be used. Some countries are more market oriented than others. Nature of expenditure may differ greatly from country to country. The distribution of the income may not be the same. The size of the population in each country should be known. Different methods of measuring the Y may be used thus nullifying comparisons.

Factors that Determine the Size of Y: The stock of factors of production and the quality of that stock. The state of technology in the economy. The national economic climate. The international economic climate. The productive capacity of the country. The actual level of national income depends on: Y = C + I + G + X - M

Factors that Determine Y Y = C + I + G + X - M Where: C = The level of consumption I = The level of investment G = The increase in government spending X = The value of exports M = The vale of imports

The Circular Flow of Income This is the amount of income in circulation at any given time. This income passes from one person to another. Note: The amount of income in circulation is greater than the amount of money in circulation. An injection is anything that increases the size of the circular flow of income, e.g. exports and investments. A leakage or a withdrawal is anything that decreases the size of the circular flow of income, e.g. imports.

Circular Flow of Income Income for supplying the factors of production Households’ income Firms’ output Spending on the output of firms Tax Government expenditure GOVERNMENT Savings Investment FINANCIAL INSTITUTIONS Imports Exports FOREIGN MARKETS Leakages Injections

The Multiplier 1 1  MPC + MPM + MPT Injections and leakages take place at the same time in any economy. The combined effects of these are calculated by using the multiplier. The multiplier is that number by which an injection is multiplied to calculate the income created by the injection. The formula for the multiplier is: Where 1 = 100% of the injection. 1 1  MPC + MPM + MPT

MPC, MPM, MPT, MPS and APC MPC = the marginal propensity to consume The % of the last increase in income spent on consumer goods. MPM = the marginal propensity to import. The % of the last increase in income spent on imported goods. MPT = the marginal propensity to tax The % of the last increase in income taken in taxation. MPS = the marginal propensity to save The % of the last increase in income saved APC = the average propensity to consume The % of total income spent on consumer goods.

Calculation of Y, MPC, MPM and Multiplier The following table shows the level of national income, consumption, investment, exports and imports at the end of Periods 1 and 2. For the purpose of this calculation you may ignore the government sector. Y C I X M Period 1 €5,800 €4,800 €1,200 €1,100 Period 2 ? €5,250 €1,300 €1,350 Calculate Y in Period 2, MPC, MPM, MPS, and the Multiplier.

Y, MPC and MPM Y in Period 2: Y = C + I + X – M Thus Y = €5,250 + €1,300 + €1,200 - €1,350 Thus Y in period 2 = €6,400 MPC is the percentage of the increase in income spent on consumer goods. Y increased by €600 and C increased by €450. Thus MPC = 450/600*100 = 75% or 0.75. MPM is the percentage of the increase in income spent on imported goods. Y increased by €600 and C increased by €150 Thus MPM = 150/600*100 = 25% or 0.25.

MPS and Multiplier MPS is the percentage of the last increase in income saved. When income increases by €600, consumption increases by only €450, therefore the other €150 must have been saved. Therefore MPS = 150/600*100 = 25% or 0.25. 1 MPS + MPM 1 .25 + .25 1 .5 The multiplier = = = = 2

Level of Consumption and Investment The level of consumption depends on the level of income, the average propensity to consume and the marginal propensity to consume. There is no control over this during the year. The level of investment, at any given time, depends on the expectations of entrepreneurs about future profits. Thus investment is not a figure that can be manipulated as nobody can force anybody to invest in a business enterprise.

Increased Government Current Expenditure Government spending is independent of its income as the government can borrow to pay for its expenditure. The government can increase its expenditure at any time as it is simply a political decision. Thus “G” can be manipulated at any given time.

Level of Exports and Imports The level of exports depends on: The level of incomes abroad. The ability of the country to manufacture, at internationally competitive prices, products for which there is an international demand. The marketing skills in the country. Thus there is no real immediate control over “X ”. The level of imports depends on: The level of income in the country and on the marginal propensity to import. Thus the level of imports are difficult to manipulate.

The Human Development Index – HDI Our National Income measures our economic standard of living. However, our welfare includes much more than economic wealth. The Human Development Index is a comparative measure of life expectancy, literacy, education and standard of living for countries worldwide. It is a standard means of measuring human well-being, especially child welfare.

Main Headings for Exam Purposes Definition. Measurement – in particular expenditure method. Use and limitations of Y statistics. Factors affecting size of Y. Circular flow of income, injections, leakages and multiplier. Determinants of Y or aggregate demand.