MANAGERIAL ECONOMICS ME 601 PROJECT PAPER STUDENT NAME: MARK MISOMALI

STUDENT ID: 24ELI-11765

INTAKE AND VENUE: EVENING 24, LILONGWE

LECTURERS NAME:

L.P. SOOLI

DATE SUBMITTED:

MARCH 09, 2012

Table of Contents
MANAGERIAL ECONOMICS ME 601............................................................................. 1 Table of Contents....................................................................................................... 1 Introduction................................................................................................................ 3 Background of the Project ......................................................................................... 3 Basic Concepts and Definitions.................................................................................. 4 Nominal and Real GDP............................................................................................ 4 Uses of National Income Statistics..............................................................................5 Income Distribution.................................................................................................... 6 Measurement of National Income............................................................................... 7 The Product (or Output) method.............................................................................7 The Income method................................................................................................. 7 The Expenditure method......................................................................................... 8 Circular flow of Income............................................................................................... 9 Problems of measuring National Income..................................................................10 Improving measurement of National Income............................................................12 Conclusion................................................................................................................ 14 References................................................................................................................ 15

THE CONCEPT OF NATIONAL INCOME

Introduction
According to J.M. Keynes, National Income is the monetary value of goods and services produced in a country during a year. It includes those goods and services whose value can be expressed in monetary terms. National Income refers to the monetary value of economic activities in a country. The goods and services included are those that can add value or contribute to the stock of the national capital. National income is an important concept because it is the basis of measuring whether the economy is doing well or poorly.

Background of the Project Governments understanding of the countrys economic performance is vital for planning and decision making. Governments use National Income figures to determine the level of economic development, asses the level of supply and demand and decide on production plans, understand how the income is distributed among the population, formulate economic policies, know the composition of national income in various sectors of the economy, measure the living standards of people, and many more. This paper has been written to fulfill the requirements of Managerial Economics module of an Executive MBA program with ESAMI. The paper will discuss the general concept of National Income and outline how Governments can improve the measurements of National Income especially to accommodate the activities of the informal sector.

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Basic Concepts and Definitions

National Income is basically the income of a country for a particular period, usually a year. Just as firms need to know how well they are doing, so does a country. The most frequently used economic indicators when assessing status of economy are Gross National Product (GNP) and Gross Domestic Product (GDP), which are explained below.

Gross National Product This is the total sum of final goods and services produced by people of a country in a year. It includes income that nationals earn from abroad and exclude income that foreigners earn in the country. GNP measures the capacity of the nationals to grow and produce Gross Domestic Product This is a measure of the total market value of all final goods and services produced within a country in a year. It includes income earned in the country by foreigners and excludes income earned abroad by nationals. GDP is a measure of the capacity of the economy. Nominal and Real GDP Nominal GDP is GDP evaluated at current market price. When there is inflation, nominal GDP can rise when actually there is no corresponding upward movement in the goods and services provided. To avoid this distortion, real GDP is used. Real GDP is GDP evaluated at market price of some base year. To obtain the real GDP, the current GDP is divided by a price index, also known as a deflator.

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Uses of National Income Statistics

Indicator of standards of living The GNP and GDP statistics are used to measure the living standards of the people in a country. GNP/GDP per capita is calculated by dividing the GNP/GDP by the population of the country. A higher figure indicates a higher standard of living and vice versa. Comparison of the level of economic activities between countries The GDP figure is usually used to compare economic status of different countries Assessing sector contribution of the economy National income figures are used to calculate the contribution from each sector of the economy. This is very helpful to establish the relationship between the various sectors of the economy Assist Governments to manage the economy The national income figures are used to view development overtime and are a basis to compare output of the nation from year to year To analyze distribution of income Governments are interested to know how the wealth is distributed among various groups of the population to assist in its planning for social services and taxation policies.

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Income Distribution
The overall figure of National Income makes more sense when it is related to the population size of the economy. The total National Income divided by the population gives National Income per capita. This is an indication of the wealth and development of a nation. In a real economy, wealth is not distributed fairly among the people or groups of people. The per capita figure does not show the distribution of the income in the economy. The Lorenz curve is used to show the distribution of income in the economy and the degree of income inequality is measured through the Gini Coefficient. Below is a diagram of the Lorenz curve for a given income distribution:Sample Income Distribution Table
Cumulative % Cumulative % of population of National Income 15 3 20 5 25 8 C 45 17 60 22 75 45 100 100

A B

DIAGRAM OF THE LORENZ CURVE

Because income is not evenly distributed the Lorenz curve does not lie along the diagonal. The area between the Lorenz curve and the diagonal line indicates the level of income distribution. The further away the Lorenz curve is from the diagonal line the greater the inequality of income distribution. The overall inequality in income is calculated by dividing the area between the Lorenz curve and the diagonal by the area of the triangle ABC.
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Measurement of National Income

There are three methods of measuring National income: - product, income, and expenditure approaches.

The Product (or Output) method

This method is based on the idea that the output of an economy is the sum of goods and services produced by the various industries. This method approaches the National income from the output side where the net value of production from the industry or sector of economy is added together. The industries could be mining, agriculture, fishing, construction etc. Since output from one industry can be used by another industry, not all the outputs are measured but instead only the final products are measured to avoid double counting

The Income method

This method is based on the idea that the income of producers is actually the market value of their products since they are paid for what they have produced. This approach looks at income as payment for the factors of production; rent for land, wages for labour,

profit for capital. This method is useful in giving indications of how income is distributed among different income groups.

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The Expenditure method

This is based on the idea that for every product sold, there is a buyer for the product. If products are sold and bought within a country, then the sum of expenditures must equal the value of goods and services produced. This approach calculates national income by adding up all the expenditures made on goods and services. It looks at all types of expenditures by households, private sector and public sector. These expenditures are grouped under Personal Consumption expenditures by individual households denoted by C. Private Expenditure Investment by private business enterprises, denoted by I. Government expenditure Government purchases denoted by G. Expenditure by foreigners Exports minus imports (net exports) denoted by NX. Therefore GDP = C+I+G+NX

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Circular flow of Income

From the preceding discussion, National Income can be viewed from three perspectives of Income, output, and Expenditure. This implies that we can view national income as total sum of income received, or total sum of goods and services produced, or total expenditure on goods and services within a year. In a closed economy, where no external forces exist, income must equal expenditure because every transaction has a buyer and a seller, and therefore, expenditure by a buyer is income for a seller. Circular flow of income is a diagrammatic representation of flow of income in an economy. According to a two-sector economy, there are only two sectors of the economy; households as buyers and firms as producers of goods and services. Below is a circular flow of income in a two-sector economy:-

Spending Revenue Market for Goods and Services

Goods & services sold services Goods & bought

Firms

Household s

Inputs for Production Land

Labour, Capital

Market for Factors of Production Wages, Rent Income Profit THE CIRCULAR-FLOW DIAGRAM

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Problems of measuring National Income

Reliability of statistics National income figures come from what is recorded. Not all entities are capable of keeping accurate records. Other transactions are poorly recorded or not recorded at all. Problems of double counting National Income includes only final goods and services. In some cases it is difficult to determine which is a final good or service. Many times it depends on the use of such services or goods Non-monetary services

National Income only includes the goods and services with monetary value. There are other equally economically valuable services such as child care, subsistence farming, and services of a house wife which may not be included in the National accounts figure. Informal trade There are considerable volume of goods and services which occur through informal trade. These are not included in the national income figures. The informal sector is defined as that part of economy which is not taxed or monitored by Governments. The regular data collection system of Governments does not cover the informal sector. The informal sector is poorly organized, with unclear production operations. The sector is mostly composed of units who deliberately avoid the established systems of business dealings to avoid taxes, or persecution if they are involved in illegal business.

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Wages and salaries in kind Some payments are made in kind for services and goods offered. Some goods are exchanged for other goods in barter type of trading. It is difficult for the national income to capture such kind of payments Lack of common method of measurement Different countries use different methods thereby making it difficult to have a fair comparison of the performance of different countries

Figures may not always mean real economic growth

If there is a war in a country, defense expenses may lead to huge Government expenditure thereby misleading users by giving a high national income figure. The Government can easily manipulate the national income figures In order to win donor confidence or in its own interest, Government can manipulate the figures.

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Improving measurement of National Income

Various stakeholders including investors and international donors rely to a great extent on the national income figures to make economic or investment decisions. Quality of the national income figures is therefore of paramount importance. Governments must therefore find ways of overcoming the difficulties encountered in the measurement of national income, including how to account for activities of the informal sector. In this chapter I will discuss some of the ways Governments can implement in order to improve the measurement of national income, especially to accommodate the activities of the informal sector

Addressing problem of unemployment Most people engage in informal business due to unavailability of proper employment. If Government can address unemployment problems they can absorb some of these people into decent and proper employment. Addressing the problem of unemployment requires Governments to have clear employment policies in their national strategies. Review fiscal policies Some of the taxes and levies are just unreasonable to scare many businesses. Governments should review its tax policy so that it is fair and reasonable. The review should include an examination of processes and procedures which firms and individuals are required to follow. Some requirements are just too cumbersome or too involving to encourage businesses and individuals to evade the system. Strengthen governance structures Some of the informal sector business is encouraged by weak governance systems. When Government has proper systems which are followed by its public servants, an atmosphere of trust can be created between Government and informal sector and it will be easy for the informal sector to abide by Government regulations including keeping of proper records and submitting required regulatory reports and returns.

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Civic Education Government should put in place sustainable civic and awareness programs to educate the citizens. Citizens should appreciate that Government initiatives to provide social and welfare services can be hampered if it does not have reliable national income figures to determine the needs of the country. Improve Government Data Collection system

Government should come up with a strategy to target the informal sector in its data collection efforts. This may require training existing personnel or hiring new staff, and acquiring modern data collection tools. Integrating the informal sector Government can explore ways of incorporating the informal sector into formal sector. This may be challenging because not all informal sector business is legal and can be integrated. The other challenge is getting information about the informal sector because some of the transactions are invisible. All the same, a careful research into the informal sector can provide opportunity for Government to consider integrating some of the operations into formal sector.

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Conclusion
National income is the best measure of the wealth of nations. Although, there are challenges in measurement of national income, governments and other stakeholders use national income figures as a basis for assessing and formulating policies about economic development.

The increasing volume of trade in the informal sector cannot be ignored and makes it imperative for governments to come up with strategies to accommodate the informal sector in order to improve the measurement of national income.

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References
1. Harcourt College publishers, Measuring National Income 2. Wikipedia, Measures of National Income, February 12, 2012

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