Circular flow

of income

Withdrawals include:
Savings:

Households save an element of

their income thus reducing
consumption.
Taxation: Amounts required by the
government reduce households ability
to spend.
Imports: Purchases from abroad result
in money leaving the circle.

Injections include:
Investments:

This is a form of spending

on future output in addition to
expenditure.
Government spending: Funds spent by
governments inject money to the circle.
Exports: Sales to abroad result in an
injection to the circle

Flow of national income

Short term and long term
National income equilibrium is reached not
only by the equality of aggregate demand
and aggregate supply but also the planned
withdrawals from the flows of national
income must also be equal to planned
injections into the circular flow of national
income i.e. withdrawals = Injections
or S + T + M = I + G + X.

Flow of national income

Short term and long term
Any difference in the balance of
payments deficit or surplus is equal to
the long values of import payments (M)
and export receipts (X) of goods and
services long.
In the short run this difference is filled
by borrowings or lendings from or to
abroad.
(a)

Flow of national income

Short term and long term
(b)

The difference between public

expenditure and public revenue can be
filled by public sector borrowing
requirements (PSBR) and public sector
debt repayments (PSDR).

Flow of national income

Short term and long term
(c) Although people who save and invest
are different even then in the long run
savings are made equal to investment
through capital market.

Flow of national income

Short term and long term
(d)

Lord Keynes explained the difference

between planned withdrawals and
planned injections in terms of trade
cycles.

Product/ output approach

This

method finds National Income by

adding the net values of all production
that has taken place in all sectors during
a given period.
The net values of production of all the
industries and sectors of the economy
plus the net income from abroad give us
the Gross National Product (GNP)..

Product/ output approach

Subtracting the total amount of

deprecation of the assets used in
production, from the figure of GNP,
gives National Income.

Product/ output approach

Definition:

Product approach
The total value of final goods and
services produced during the year.
The term final goods and services
relates to those that are consumed. It
does not include components or capital
goods which are termed intermediate
goods.

Difficulties associated with the output method

Double

counting: The outputs of some firms

become inputs of others. For example, the
output from a factory making electrical
components will be used as inputs in the motor
industry. If the total value of both industries'
output were included in the aggregate then the
value of the components used in the motor
industry would be included twice.
To avoid this problem only the value added at
each stage of production is added.

Income approach
Definition:

Income approach
The total value of all the incomes
earned from producing goods and
services during the year

Income approach
This

method measures the National

Income after it has been distributed
and
appears as income earned or
received by individuals of the
country.
This method estimates National Income
by adding up the rent of land, wages of
employees, interest and profit on capital
and income of self-employed people.

Income approach
These

incomes will equal the total value

added in the process of making the
product.

Income approach
The calculation does not include:
ignore Transfer Payments
Transfer payment are payment to
household and firm in return for no
productive efforts
(e.g. state pension, unemployment
benefits and other social payments)
Subsidies to farmers
.

Income approach
these are ignored to avoid double
counting the income:
when the original household earns it
prior to it being taxed
when the household receiving the
transfer payment receives it from the
government.
Therefore the income are recorded
as gross.(i.e pretax)

Income approach

Income gained from stock

appreciation. This is due to inflation and
not a rise in output.
Income not declared to the tax
authorities (the black or shadow
economy).
Activity such as subsistence farming
and barter transaction.

Difficulties associated with the

income method
Double

counting also becomes a

problem when using the income
method. The sum of all factor
incomes is not the same as the sum
of all personal incomes as these
also include transfer incomes,
which are subsistence payments for
no actual productive process.

Difficulties associated with the

income method
DIY
In some cases an imputed value is
used for instance the value of owner
occupied housing where the market
rents of similar properties are used as
guidelines
A problem using the income method is
the non-distribution of some factor
incomes to factors of production

Expenditure approach
The

expenditure approach involves

counting the expenditure in the
economy on goods and service, by
different groups of people.
These groups were identified in the
original definition of GDP as
Consumption,
Investment, Government Spending,
Exports and Imports.

Expenditure approach
DEF:

The total value of expenditure

on purchasing final goods and
services during the year.
This is measured by adding up the
expenditure that has happened in the
country ,and includes: household
consumption, government expenditure
on consumables, export demand.

Expenditure approach

Expenditure approach
The above figures show that Personal
Consumption accounts for the largest
portion of GDP with Government Spending as
the second largest component of the economy.
Note that social security spending (i.e.
paying benefits to disadvantaged members of
society) does not feature because it is a transfer
payment. It is counted in the Personal
Consumption part of the calculation,
rather than Government Spending.

Expenditure approach
Investment

Spending is categorized
into different types (I and G) and Net
Exports simply aggregates the outflows
and inflows of the countrys trading.

Difficulties associated with the

expenditure method
, Do-It-Yourself
Figures are distorted by indirect taxes and
subsidies for which an adjustment must be
made.
Further adjustments are necessary for
changes in stock levels, for exports net of
imports and an allowance for depreciation to
allow for the capital used up in the production
process.

Conclusion
The above methods all agree on the figure
for Gross Domestic Product.
The table below explains how this figure
can be converted from GDP, to GNP, and
finally into a value for Net National
Income.

Difficulties in measuring
national income
Lack

of trained staff:
Illiteracy/unreliable record keeping:
Inadequate information caused by poor
collection procedures.
Not all information about the size of an
economy is captured:
1. Barter transactions
2. hidden economy

Difficulties in measuring
national income
The

process only measures what is

defined as legal production. Many
kinds of productive works such as
services of housewives, agricultural
products used by farmer for own
consumption are ignored.

Difficulties in measuring
national income
Double

counting is a problem.
double count production
Transfer payment:
Income of foreign firms creates a
complication in terms of whether to
include it in national income of the
country of operation or country of origin.

Measures of national income

can be used to make:

single country comparisons (e.g.

tracing the economic progress of
Pakistan over a period of time); and
international comparisons (e.g.
comparing the economic performance of
Pakistan to that of other countries).

Difficulties in making single

country comparisons
Inflation

distortions
Changes in the price level between
years can give the impression of
economic growth when in fact it is
inflation.

Overcome
Overcome by the use of a GDP
deflator to reduce current values to real
values in terms of the prices of a chosen
base year.

Difficulties in making single

country comparisons
Standard

of living is usually measured

as national income per capita which
overlooks:

Difficulties in making single

country comparisons
1.
2.

3.

Inequality in the distribution of output

between the rich and poor.
The social costs of factors which affect
the well-being of others without cost
these are called externalities), for
example pollution, stress, crime etc.
Doesnt reflect the different amounts
of leisure enjoyed by different
economies

Difficulties in making
international comparisons
Problems in using national income figures to compare
countries include
differences in classification of activities between
countries
Differences in the extent to which they rely on the
market to provide services and goods
Exchange rate distortions harm comparability of figures
Different accounting conventions
Different climates e.g. hot countries spend less on
heating and clothing than cold ones yet their standard
of living is unaffected.

Difficulties in making
international comparisons
Different

production priorities: e.g. one

country may produce consumer goods
while another may produce capital
goods or defense goods. Both will have
the
same income though the standards of
living will be different.