2.4 National Income

Income

A flow concept, referring to money/value of goods/services received over a period of time

(e.g. salary - annually, wages - hourly, interest - monthly, dividends - quarterly)

Wealth

A stock concept, referring to the value of assets held at a point in time

(e.g. houses, cars, shares, savings, jewellery)

Relationship between income and wealth

Income and wealth have a circular relationship; income can be generated by wealth, and wealth can be generated by income

Circular flow of income model (John Maynard Keynes)

Evaluation of the circular flow of income model

Short-term withdrawals may lead to long-run injections

National income/GDP is generated as money flows back and forth between households and firms, therefore national income per year increases if there is more income/money being circulated or if the velocity of spending increases

If injections increase, there is more income circulating, therefore there is more income/GDP being generated per period of time

If injections decrease, there is less income circulating, therefore there is less income/GDP being generated per period of time

If withdrawals increase, there is less income circulating, therefore there is less income/GDP being generated per period of time

If withdrawals decrease, there is more income circulating, therefore there is more income/GDP being generated per period of time

The multiplier process

The relationship between an initial change in income and the resulting larger change in national income

Can be positive and negative

The multiplier ratio

Measures the size of the effect of national income/GDP following an injection, represented by the constant ‘k’

k = 1/(1-MPC) or k = 1/MPW

Change in national income/GDP formula

Final change in national income = k x injection

Marginal propensity to consume (MPC)

The proportion of the last unit of income earned that is used for spending/consumption

MPC is always 1 or below, as you cannot spend more than you earn

Marginal propensity to save (MPS)

The proportion of the last unit of income earned that is saved

Marginal propensity to tax (MPT)

The proportion of the last unit of income earned that is taxed

Marginal propensity to import (MPM)

The proportion of the last unit of income earned that is spent on imports

Marginal propensity to withdraw (MPW)

The proportion of the last unit of income earned that is withdrawn

Marginal propensity to withdraw formula

MPW = MPS + MPT + MPM

MPC and MPW relationship

Since all income is either spent or withdrawn, MPC + MPW = 1

Thus, the formula MPW = 1 - MPC is derived