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National income is the total value of the new output of an economy over a period of time
The output is produced by the physical (machinery) and human capital in the economy
Income is a flow in the economy, whereas wealth is a stock of assets that can be used to generate income
Nominal and real GDP are often used to measure national income
Nominal GDP is the actual value of all goods and services produced in an economy in a one-year period
There has been no adjustment to the amount based on the increase in general price levels (inflation)
The word nominal refers to the fact that the metric has not been adjusted for inflation
Real GDP is the value of all goods and services produced in an economy in a one-year period, adjusted for inflation
E.g. If nominal GDP is £100bn and inflation is 10%, then real GDP is £90bn
Real national income is an indicator of economic performance
If real income is rising, then the economic performance of the country is improving
It is also very likely that the standard of living in the economy is also improving
If real income falls during a period of recession, it is likely that there will be a fall in the standard of living of individuals in the economy
The rate of change of national income measures the change in economic growth in an economy
Both the level and rate of change in national income are valuable for cross-country comparisons
The Closed Circular Flow of Income Model
The circular flow of income model is used to illustrate national income and the flow of money, resources and goods in an economy
There is a simple model which shows the money flows in a 'closed economy'
This shows money flows between households and firms
There is a more complex model which adds in other economic agents, including the government, financial sector and foreign trade (net exports)
The Open Circular Flow of Income Model
An open circular flow of income demonstrates the relationship between all of the economic agents that interact in a global world
There are high levels of interdependence between households, firms, the government, the financial sector, and the foreign sector (foreign firms and households)
Diagram: Circular flow in an open Economy
An open economy is one that trades with the world. North Korea is a closed economy
Diagram analysis
Households and firms have been explained in the closed circular flow of income model above
Government: The government influences the size of the circular flow through its taxation (T) and spending policies (G)
Financial sector: The financial sector influences the size of the circular flow by providing funds for Investment (I) and a safe place for households and firms to store their savings (S)
Foreign sector: Globalisation means that the level of exports (X) and imports (M) significantly affects the size of the circular flow of income in most countries
Income = Output = Expenditure
With reference to the circular flow of income model, national income can be calculated using three possible approaches
The expenditure approach
This approach adds up the value of all the expenditures in the economy in a year and includes consumption (C), government spending (G), investment (I) by firms and net exports (X - M)
Nominal GDP = C + I + G + (X-M)
The income approach
This approach adds up the payments (rewards) for the factors of production in a year and includes the wages from labour (W), rent from land (R), interest from capital (I) and profit from entrepreneurship (P)
National Income = W + R + I + P
The output approach
This approach adds up the value of all finished goods/services produced within the economy each year (national output)
All approaches should provide the same figure
One agent's expenditure is another agent's income
The value of finished goods ready for sale is equal to the expenditure paid to acquire them
The value of GDP is different to the volume of GDP
National income is the total value of the new output of an economy over a period of time
The output is produced by the physical (machinery) and human capital in the economy
Income is a flow in the economy, whereas wealth is a stock of assets that can be used to generate income
Nominal and real GDP are often used to measure national income
Nominal GDP is the actual value of all goods and services produced in an economy in a one-year period
There has been no adjustment to the amount based on the increase in general price levels (inflation)
The word nominal refers to the fact that the metric has not been adjusted for inflation
Real GDP is the value of all goods and services produced in an economy in a one-year period, adjusted for inflation
E.g. If nominal GDP is £100bn and inflation is 10%, then real GDP is £90bn
Real national income is an indicator of economic performance
If real income is rising, then the economic performance of the country is improving
It is also very likely that the standard of living in the economy is also improving
If real income falls during a period of recession, it is likely that there will be a fall in the standard of living of individuals in the economy
The rate of change of national income measures the change in economic growth in an economy
Both the level and rate of change in national income are valuable for cross-country comparisons
The Closed Circular Flow of Income Model
The circular flow of income model is used to illustrate national income and the flow of money, resources and goods in an economy
There is a simple model which shows the money flows in a 'closed economy'
This shows money flows between households and firms
There is a more complex model which adds in other economic agents, including the government, financial sector and foreign trade (net exports)
The Open Circular Flow of Income Model
An open circular flow of income demonstrates the relationship between all of the economic agents that interact in a global world
There are high levels of interdependence between households, firms, the government, the financial sector, and the foreign sector (foreign firms and households)
Diagram: Circular flow in an open Economy
An open economy is one that trades with the world. North Korea is a closed economy
Diagram analysis
Households and firms have been explained in the closed circular flow of income model above
Government: The government influences the size of the circular flow through its taxation (T) and spending policies (G)
Financial sector: The financial sector influences the size of the circular flow by providing funds for Investment (I) and a safe place for households and firms to store their savings (S)
Foreign sector: Globalisation means that the level of exports (X) and imports (M) significantly affects the size of the circular flow of income in most countries
Income = Output = Expenditure
With reference to the circular flow of income model, national income can be calculated using three possible approaches
The expenditure approach
This approach adds up the value of all the expenditures in the economy in a year and includes consumption (C), government spending (G), investment (I) by firms and net exports (X - M)
Nominal GDP = C + I + G + (X-M)
The income approach
This approach adds up the payments (rewards) for the factors of production in a year and includes the wages from labour (W), rent from land (R), interest from capital (I) and profit from entrepreneurship (P)
National Income = W + R + I + P
The output approach
This approach adds up the value of all finished goods/services produced within the economy each year (national output)
All approaches should provide the same figure
One agent's expenditure is another agent's income
The value of finished goods ready for sale is equal to the expenditure paid to acquire them
The value of GDP is different to the volume of GDP
National income is the total value of the new output of an economy over a period of time
The output is produced by the physical (machinery) and human capital in the economy
Income is a flow in the economy, whereas wealth is a stock of assets that can be used to generate income
Nominal and real GDP are often used to measure national income
Nominal GDP is the actual value of all goods and services produced in an economy in a one-year period
There has been no adjustment to the amount based on the increase in general price levels (inflation)
The word nominal refers to the fact that the metric has not been adjusted for inflation
Real GDP is the value of all goods and services produced in an economy in a one-year period, adjusted for inflation
E.g. If nominal GDP is £100bn and inflation is 10%, then real GDP is £90bn
Real national income is an indicator of economic performance
If real income is rising, then the economic performance of the country is improving
It is also very likely that the standard of living in the economy is also improving
If real income falls during a period of recession, it is likely that there will be a fall in the standard of living of individuals in the economy
The rate of change of national income measures the change in economic growth in an economy
Both the level and rate of change in national income are valuable for cross-country comparisons
The Closed Circular Flow of Income Model
The circular flow of income model is used to illustrate national income and the flow of money, resources and goods in an economy
There is a simple model which shows the money flows in a 'closed economy'
This shows money flows between households and firms
There is a more complex model which adds in other economic agents, including the government, financial sector and foreign trade (net exports)
The Open Circular Flow of Income Model
An open circular flow of income demonstrates the relationship between all of the economic agents that interact in a global world
There are high levels of interdependence between households, firms, the government, the financial sector, and the foreign sector (foreign firms and households)
Diagram: Circular flow in an open Economy
An open economy is one that trades with the world. North Korea is a closed economy
Diagram analysis
Households and firms have been explained in the closed circular flow of income model above
Government: The government influences the size of the circular flow through its taxation (T) and spending policies (G)
Financial sector: The financial sector influences the size of the circular flow by providing funds for Investment (I) and a safe place for households and firms to store their savings (S)
Foreign sector: Globalisation means that the level of exports (X) and imports (M) significantly affects the size of the circular flow of income in most countries
Income = Output = Expenditure
With reference to the circular flow of income model, national income can be calculated using three possible approaches
The expenditure approach
This approach adds up the value of all the expenditures in the economy in a year and includes consumption (C), government spending (G), investment (I) by firms and net exports (X - M)
Nominal GDP = C + I + G + (X-M)
The income approach
This approach adds up the payments (rewards) for the factors of production in a year and includes the wages from labour (W), rent from land (R), interest from capital (I) and profit from entrepreneurship (P)
National Income = W + R + I + P
The output approach
This approach adds up the value of all finished goods/services produced within the economy each year (national output)
All approaches should provide the same figure
One agent's expenditure is another agent's income
The value of finished goods ready for sale is equal to the expenditure paid to acquire them
The value of GDP is different to the volume of GDP
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An open economy is one that trades with the world. North Korea is a closed economy
