National Income

Meaning
Total market value of the final goods and
services produced in an economy in a
year
 CIRCULAR FLOW OF INCOME
AND PRODUCT
 Pictorial illustration of Interrelation of
economic activity

 Involves two kinds of flows

 Money flows

 Real flows (flow of Goods and Services)

 CIRCULAR FLOW OF INCOME
AND PRODUCT
 Closed Economy  Open Economy

 Two sector model  Four sector model

Households Households

Firms
Firms
Government
 Three sector model
Rest of the world
Inclusion of Government Sector
 TWO SECTOR MODEL
WITHOUT SAVINGS
 Two sectors – Households and Firms
 Households spend their entire income on consumption (Y=C)
 Savings=Zero as Y=C+S
 Firms sell all that is produced to Households
 Firms spend their entire income on Rent, Wages, Interest and
Profit. There are no undistributed profits.
 There are no leakages and injections - Circular flow of
Income remains constant
 Such an economy has two types of markets
 Product Market for Goods and services
 Factor Market for Factors of Production
 TWO SECTOR MODEL WITH
SAVINGS
 Savings reduce consumption expenditure.
 If households hoard a part of their income- leakage.
 If households save with financial institutions who in
turn give it out as loans to firms for investment the
money is injected back into the economy.
 Households are Net Savers while Firms are Net
Borrowers
 If S > I, Income flow will decline as
Leakage>Injection
 If S < I, Income flow will increase.
TWO SECTOR MODEL WITH SAVINGS

HOUSE Consumption Expenditure

CONSUMPTION
Consumption EXP
Expenditure FIRMS
HOLDS

FACTOR PAYMENTS

SAVING

FINANCIAL SYSTEM BORROWING

(INVESTMENT)
 THREE SECTOR MODEL

 Three sectors- Firms, Households and Government

 Government earns revenue from taxes (T) which includes
 Personal taxes on Households (T1)
 Corporation tax on Firms (T2)
 T= T1 + T2
 Govt. spends this revenue on
 Payment made to Households for services (G1)
 Purchasing goods from Firms (G2)
 Making Transfer Payments to Households (G3)
 Giving Subsidies to Firms (G4)
 G= G1+ G2 + G3 + G4
 THREE SECTOR MODEL
 Firms may have undistributed profits (retained
earnings) to be used for investment
 This implies that the PY of the HH < NY of
the country
 If the Government has a Deficit in the Budget
(G > T) it will borrow from the Financial
System
 Conversely it will save if it has a Surplus in the
Budget (G < T)
 THREE SECTOR MODEL

CONSUMPTION EXP.
HOUSEHOLDS Consumption
Consumption Expenditure FIRMS
Expenditure
FACTOR PAYMENTS
S
FINANCIAL SYSTEM B

S B
A O
V R
I R
N O
G W
IN
G

GOVT. EXP. ON SERVICES GOVT. EXP. ON GOODS AND

AND TRANSFER PAYMENTS GOVERNMENT SUBSIDIES (G2 + G4)
(G1 + G3)
 FOUR SECTOR MODEL
OPEN ECONOMY
 Inclusion of “Rest Of the World”
 Imports (M) cause an outflow of Income -
Leakage
 Exports (X) cause an inflow of Income -
Injection
 Factor Income to abroad (P) will cause the
circular flow of income to decline – Leakage
 Factor Income from abroad (R) will cause the
circular flow of income to rise – Injection
 OPEN ECONOMY
GOVT
TAXES

Taxes
S B

FINANCIAL SYSTEM
HH S B FIRMS
CONSUMPTION EXP.

FACTOR PAYMENTS

ROW
 RELATION BETWEEN
LEAKAGES AND INJECTIONS
 LEAKAGES  INJECTIONS
 Savings (S)  Investments (I)
 Taxes (T)  Government
 Imports (M) Expenditure (G)
 International Factor  Exports (X)
Income to abroad  International Factor
 International Transfer Income from abroad
Payments to abroad  International Transfer
Payments from abroad
For stability in the Circular
Flow of Income
Leakages = Injections