13
(National Income Meaning, Circular Flow of
Income, National Income Aggregates and
Measurement of National Income)
QUICK
NATIONAL INCOME
National income is defined as the monetary value of all final goods and services produced by the normal
residents of the country whether operating within the domestic territory of the country or outside in a year.
Points which should be noted in the definition of National income are:
1. Monetary Value: N.I. is always expressed in monetary terms. Since a variety of goods and services are
produced in the country we need a common denominator to add them up. This money is used as a measuring
rod to measure the value of all goods and services.
2. Final Goods Services: To measure N.I. we include value of final goods and services only because value of
intermediate goods and services is already included in the value of final products. If we add value of
intermediate goods in national income it will become double counting, i.e., adding value of a commodity in
N.I. more than once. It gives an inflated N.I.
3. N.l. is a Flow: N.I. follows a flow concept because it is measured over a period time, i.e., 1 year, thus it is a
flow of goods and services and not stock.
4. Current Output: N.I. includes the value of currently produced goods and services. Pure exchange
transactions such as sale and purchase of second hand goods, securities and transfer payment are not included
in N.I. because they do not contribute anything to the current year production. Sale and purchase of second
hand goods are not included in N.I. but value of the services of commission agents involved in second hand
sales and value of the services of brokers, i.e., brokerage is included in the N.I. Transfer payment is also not
included in N.I. They are unilateral payments for which no productive services are rendered in current year,
e.g., social security payments, donations, pensions, etc.
5. Normal Resident: N.I. is the value of the final goods and services produced by the normal residents of the
country.Normal residents are those people who ordinarily reside in a country in which they live and whose
economic interest lies in that country. They may or may not be the citizen of the country. It means normal
residents include nationals as well as foreign nationals.
6. Domestic Territory: It refers to the geographical or political boundary of the country excluding foreign
embassy and international institutions like U.N., W.H.O., offices located within the geographical territory and
including the embassy of this country located outside its geographical territory.
, CIRCULAR FLOW OF INCOME
Circular flow of income is defined as the flow of payments and receipts for goods and services and factor
services among different sectors of an economy. There are four sectors in an economy, which are as follow:
1. Household Sectors
Features:
(i) They are owners of all factors of productions.
(ii) They receive income in the form of wages, rent, interest and profit. They also get some transfer payments
from the Government.
(iii) They are the consumers of goods and services, i.e., they make consumption expenditure to business
sectors. They also pay tax to the Government.
(iv) Savings by household sectors go to the capital market (Bank, stock market, etc.)
(v) Household sector exports its man-power to foreign sectors.
(vi) They make payments to foreign sector for whatever they import.
2. Firm/Producer/Business Sectors
Features:
(i) They hire factors of productions from the household sectors.
(ii)They produce and sell goods and services to the household sector and receive income from that sector.
(iii)They obtain subsidy from the Government.
(iv) They make factors payments to household sector and pay taxes to the Government. Savings by firms also
go to the capital market.
(v)They take loan from capital market and invest in business sectors.
(vi)They earn export income.
(vii)They make payments to foreign sector to whatever they import.
3. Government Sectors
Features:
(i) Government sector receives direct taxes from household sector and indirect taxes from firms.
(ii) Government sector makes transfer payments to household sector and gives subsidies to business sector
like food subsidy, fertiliser subsidy, etc.
(iii) Government savings also go to capital market.
4. Foreign / External / Rest of the World Sector
Features:
(i) Rest of the world sector receives payments from the firms and household for their imports.
(ii) Rest of the world makes payments to the firm's imports.
(iii) External sector employs man-power from household sector and pays for them.
Types of Circular Flow of Income: Circular flow may be of two types: (i) Real flow, and (ii) Money flow.
(i) Real Flow: It shows the flow of goods and services through different sectors of economy.
,(ii) Money Flow: Income flows as money flow shows flow of money across different sectors of economy.
(a) Two-Sector Model of Circular Flow of Income: An economy consists of households and firms
households, the suppliers of factor services to the firms, receive their rewards in form of wages, rent, interest
and profits. They spend this money on the purchase of goods and services produced by the firms. Thus,
income flows in a circular way between the households and the firms. Equilibrium in the two-sector model
will take place when savings are equal to investments.
In this model, the condition for equilibrium is S = I or C + S = C + I. If S > I then the income flow decreases
because S is known as withdrawal or leakage in circular flow. If S < I then the income flow increases because
investment is known as injection in circular flow.
(b) Three-Sector Model of Circular Flow of Income: In this model three sectors, viz., households, firms and
Government operate. Here the additional flows of income take place in form of taxes by the Government
from household and firms, and flows of factor payments, transfer payments and subsidies from Government
to household and firms.
, In the above model leakages are savings and taxes. Injections are investment and Government expenditure on
subsidies. If Savings + Taxes = Investments + Subsidies, then the flow will be in equilibrium. An economy with
three sectors is known as a closed economy also.
(c) Four-Sector Model: A modern economy is a four-sector economy, where: (i) the households, (ii) the firms,
(iii) the Government, and (iv) the rest of the world sectors exist. The circular flow of income goes on moving
without interruption. In this model, the additional flows take place on account of exports and imports.
In the given model leakages are savings, taxes and imports. Injections are investment, Government
expenditure and exports. Thus,
Savings + Taxes + M (Imports) = Investment + Govt. exp + X (Exports)
Then economy will be in equilibrium.
An economy with four sector is known as open economy also.
Leakages and Injections: Leakages are withdrawals like savings, taxes and imports. They reduce the flow of
income. Injections are investments, subsidies and exports. They increase the flow of income.
Importance of Circular Flow Models: Circular flow models are important because they:
(i) show interdependence between sectors,
(ii) provide knowledge of structure of the economy,
(iii) facilitate the estimation of national income,
(iv) give information on important macro variables, and
(v) give information about injections and withdrawals.
(National Income Meaning, Circular Flow of
Income, National Income Aggregates and
Measurement of National Income)
QUICK
NATIONAL INCOME
National income is defined as the monetary value of all final goods and services produced by the normal
residents of the country whether operating within the domestic territory of the country or outside in a year.
Points which should be noted in the definition of National income are:
1. Monetary Value: N.I. is always expressed in monetary terms. Since a variety of goods and services are
produced in the country we need a common denominator to add them up. This money is used as a measuring
rod to measure the value of all goods and services.
2. Final Goods Services: To measure N.I. we include value of final goods and services only because value of
intermediate goods and services is already included in the value of final products. If we add value of
intermediate goods in national income it will become double counting, i.e., adding value of a commodity in
N.I. more than once. It gives an inflated N.I.
3. N.l. is a Flow: N.I. follows a flow concept because it is measured over a period time, i.e., 1 year, thus it is a
flow of goods and services and not stock.
4. Current Output: N.I. includes the value of currently produced goods and services. Pure exchange
transactions such as sale and purchase of second hand goods, securities and transfer payment are not included
in N.I. because they do not contribute anything to the current year production. Sale and purchase of second
hand goods are not included in N.I. but value of the services of commission agents involved in second hand
sales and value of the services of brokers, i.e., brokerage is included in the N.I. Transfer payment is also not
included in N.I. They are unilateral payments for which no productive services are rendered in current year,
e.g., social security payments, donations, pensions, etc.
5. Normal Resident: N.I. is the value of the final goods and services produced by the normal residents of the
country.Normal residents are those people who ordinarily reside in a country in which they live and whose
economic interest lies in that country. They may or may not be the citizen of the country. It means normal
residents include nationals as well as foreign nationals.
6. Domestic Territory: It refers to the geographical or political boundary of the country excluding foreign
embassy and international institutions like U.N., W.H.O., offices located within the geographical territory and
including the embassy of this country located outside its geographical territory.
, CIRCULAR FLOW OF INCOME
Circular flow of income is defined as the flow of payments and receipts for goods and services and factor
services among different sectors of an economy. There are four sectors in an economy, which are as follow:
1. Household Sectors
Features:
(i) They are owners of all factors of productions.
(ii) They receive income in the form of wages, rent, interest and profit. They also get some transfer payments
from the Government.
(iii) They are the consumers of goods and services, i.e., they make consumption expenditure to business
sectors. They also pay tax to the Government.
(iv) Savings by household sectors go to the capital market (Bank, stock market, etc.)
(v) Household sector exports its man-power to foreign sectors.
(vi) They make payments to foreign sector for whatever they import.
2. Firm/Producer/Business Sectors
Features:
(i) They hire factors of productions from the household sectors.
(ii)They produce and sell goods and services to the household sector and receive income from that sector.
(iii)They obtain subsidy from the Government.
(iv) They make factors payments to household sector and pay taxes to the Government. Savings by firms also
go to the capital market.
(v)They take loan from capital market and invest in business sectors.
(vi)They earn export income.
(vii)They make payments to foreign sector to whatever they import.
3. Government Sectors
Features:
(i) Government sector receives direct taxes from household sector and indirect taxes from firms.
(ii) Government sector makes transfer payments to household sector and gives subsidies to business sector
like food subsidy, fertiliser subsidy, etc.
(iii) Government savings also go to capital market.
4. Foreign / External / Rest of the World Sector
Features:
(i) Rest of the world sector receives payments from the firms and household for their imports.
(ii) Rest of the world makes payments to the firm's imports.
(iii) External sector employs man-power from household sector and pays for them.
Types of Circular Flow of Income: Circular flow may be of two types: (i) Real flow, and (ii) Money flow.
(i) Real Flow: It shows the flow of goods and services through different sectors of economy.
,(ii) Money Flow: Income flows as money flow shows flow of money across different sectors of economy.
(a) Two-Sector Model of Circular Flow of Income: An economy consists of households and firms
households, the suppliers of factor services to the firms, receive their rewards in form of wages, rent, interest
and profits. They spend this money on the purchase of goods and services produced by the firms. Thus,
income flows in a circular way between the households and the firms. Equilibrium in the two-sector model
will take place when savings are equal to investments.
In this model, the condition for equilibrium is S = I or C + S = C + I. If S > I then the income flow decreases
because S is known as withdrawal or leakage in circular flow. If S < I then the income flow increases because
investment is known as injection in circular flow.
(b) Three-Sector Model of Circular Flow of Income: In this model three sectors, viz., households, firms and
Government operate. Here the additional flows of income take place in form of taxes by the Government
from household and firms, and flows of factor payments, transfer payments and subsidies from Government
to household and firms.
, In the above model leakages are savings and taxes. Injections are investment and Government expenditure on
subsidies. If Savings + Taxes = Investments + Subsidies, then the flow will be in equilibrium. An economy with
three sectors is known as a closed economy also.
(c) Four-Sector Model: A modern economy is a four-sector economy, where: (i) the households, (ii) the firms,
(iii) the Government, and (iv) the rest of the world sectors exist. The circular flow of income goes on moving
without interruption. In this model, the additional flows take place on account of exports and imports.
In the given model leakages are savings, taxes and imports. Injections are investment, Government
expenditure and exports. Thus,
Savings + Taxes + M (Imports) = Investment + Govt. exp + X (Exports)
Then economy will be in equilibrium.
An economy with four sector is known as open economy also.
Leakages and Injections: Leakages are withdrawals like savings, taxes and imports. They reduce the flow of
income. Injections are investments, subsidies and exports. They increase the flow of income.
Importance of Circular Flow Models: Circular flow models are important because they:
(i) show interdependence between sectors,
(ii) provide knowledge of structure of the economy,
(iii) facilitate the estimation of national income,
(iv) give information on important macro variables, and
(v) give information about injections and withdrawals.
