The-circular-flow-of-income

ThecircularflowofincomeSummary1,Nationalincomecanbemeasuredinthreeways:asnationaloutput,nationalexpenditureornationalincome.2,ThemostcommonlyusedmeasureofnationalincomeisGrossDomesticProduct(GDP).OthermeasuresincludeGrossNationalProduct(GNP)andNetNationalProduct(NNP).Allthesemeasurescanbeatmarketpricesorfactorycost.3,Nationalincomestatisticsareusedbyacademicstoformulateandtesthypotheses.Theyareusedbypolicymakerstoformulateeconomicpolicybothonamicroeconomicandmacroeconomiclevel.Theyareoftenusedasaproxymeasureforthestandardsoflivingandtocomparelivingstandardsbetweencountriesandwithinacountryovertime.4,Nationalincomestatisticscanbeinaccuratebecauseofstatisticalerrors,theexistenceoftheblackeconomy,ofnon-tradedsectors,anddifficultieswithvaluingpublicsectoroutput..5,Problemsoccurwhencomparingnationalincomeovertimebecauseofinflation,theaccuracyandpresentationofstatistics,changesinpopulation,thequalityofgoodsandservicesandchangesinincomedistribution..6,furtherproblemsoccurwhencomparingnationalincomebetweencountries.Inparticular,anexchangeratehastobeconstructedwhichaccuratelyreflectsdifferentpurchasingpowerparities.Income,outputandexpenditureMacroeconomicsisconcernedwiththeeconomyasawhole.Akeymacroeconomicvariableistheleveloftotaloutputinaneconomy,oftencalledNATIONALINCOME.Thesearethreewaysinwhichnationalincomecanbecalculated.Tounderstandwhy,consideraverysimplemodelofeconomywherethereisnoforeigntradeandnogovernment.Inthiseconomy,thereareonlyhouseholdsandfirmswhichspendalltheirincomeandrevenues.HouseholdsowntheWEALTHofnation.Theyownthestockofland,labourandcapitalusedtoproducegoodsandservices.Theysupplythesefactorstofirmsinreturnforrents,wages,interestsandprofits-therewordstothefactorofproduction.Theythenusethismoneytobuygoodsandservices.Firmsproducegoodsandservices.Theyhirefactorsofproductionfromhouseholdsandusethesetoproducegoodsandservicesforsalebacktohouseholds.Householdsreceivepaymentsforhiringtheirland,labourandcapital.Theyspendallthatmoneyonthegoodsandservicesproducedbyfirms.Analternativewayofputtingthisistoexpressthesemoneypaymentsinrealterms,takingintoaccountchangesinprices.Therealflowofproductsandfactorservicesisshowninblack.Householdssupplyland,labourandcapitalinreturnforgoodsandservices.Thecircularflowinincomemodelcanbeusedtoshowthattherearethreewaysofmeasuringthelevelofeconomicactivity.1)Nationaloutput(O)2)Nationalexpenditure(E)3)Nationalincome(Y)Soincome,expenditureandoutputarethreewaysofmeasuringthesameflow.Toshowthattheymustbeidenticalandnotjustequal,weusethe≡sign.O≡E≡YInjectionsandwithdrawalsAninjectionintothecircularflowisspendingwhichdoesnotcomefromhouseholds.Therearethreeinjections.Investment.GovernmentspendingExportsAwithdrawalofleakagefromthecircularflowisspendingwhichdoesnotflowbackfromhouseholdstoforms.Therearethreewithdrawalswhichcorrespondtothethreeinjections.SavingbyhouseholdsTaxesImportsInequilibrium,whenthereisnotendencytochange,injectionsmustequalwithdrawals.Whenthishappensoutput,expenditureandincomeflowingroundthecircularflowremainthesame.Wheninjectionsaregreaterthanwithdrawals,nationalincomewillrisetoreflectthegreaterspending.Equally,whenwithdrawalsarelessthaninjections,spendingwillfall.Forexample,ariseininvestmentwillincreasespendingintheeconomy.Ariseinsavingwillreducespending.TransferpaymentsNotalltypesofincomeareincludedinthefinalcalculationofnationalincome.Someincomesarereceivedwithouttherebeinganycorrespondingoutputintheeconomy.Forinstance:ThegovernmentpaysNationalInsuranceandsocialsecuritybenefitstoindividuals,buttherecipientsproducenothinginreturn..Studentsreceivestudentgrantsfromgovernment,butagainproducenothingwhichcanbesold.Childrenreceivepocketmoneyandallowancesfromtheirparents.Anindividualsellingasecondhandcarreceivesmoney,butnotnewcariscreated.Theseincomes,calledTRANSFERPAYMENTS,areexcludedfromfinalcalculationsofnationalincome.Forinstance,governmentspendinginnationalincomeispublicexpenditureminusspendingonbenefitsandgrants.TheaccuracyofnationalincomestatisticsNationalincomestatisticsareinaccurateforanumberofreasons.Statisticalinaccuracies.Nationalincomestatisticsarecalculatedfrommillionsofdifferentreturnstothegovernment.Inevitablymistakesaremade:returnsareinaccurateorsimplynotcompleted.Thestatisticsareconstantlybeingrevisedinthelightoffreshevidence.Althoughrevisionstendtobecomesmallerovertime,nationalincomestatisticsarestillbeingreviseddecadesafterfirstpublication.Thehiddeneconomy.TaxessuchasVAT,incometaxandNationalInsurancecontrubutions,andgovernmentregulationssuchashealthandsafetylaws,imposeaburdenonworkersandbusinesses.SomearetemptedtoevadetaxesandtheyarethensaidtoworkintheBLACK,HIDDENORINFORMALECONOMY.Inthebuildingindustry,soinstance,itiscommonforworkerstobeself-employedandtounder-declareornotdeclaretheirincomeatalltothetaxauthorities.Taxevasionisthedominantmotiveforworkinginthehiddeneconomybutafesalsoclaimwelfarebenefitstowhichtheyarenotentitled.Thesizeofthehiddeneconomyisintheformofcash.Cheques,creditcards,etc.couldallbetracedbytaxauthorities.Taxevasioni