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Investment and national income

Briefly explain national income concept and use the multiplier theory to show the effects

that an increase in investment would have on national income.

National income is a measure of the value of the output of goods and services produced

by an economy over a period of time. Investment (I) means expenditure on goods and

services not for current consumption but for the expansion of the productive capacity.

The multiplier theory refers to the extent of the growth of national income when

investment grows. To explain how an increase in investment may lead to a rise in national

income, an example is used. Increase in government spending by !. " million to build

an expressway can lead to an increase in national income. #ssume that !. " million is

invested in building expressway. !. " million goes to the public in the economy in the

form of wages, salaries, interest and dividends. Therefore, !. " million new income is

created. These people with !. " million will spend some of the newly created income

on food, clothing and consumer durables. If marginal propensity to save ($%!) & '.,

then !. *',''' is spent while !. ',''' is saved. This is the induced rise in

consumption expenditure and increase spending will stimulate an increase in increase in

output and employment as producers reali+e the presence of demand. !. *',''' will

reappear as income for another group of people and if $arginal %ropensity to onsume

$% & '.*, they will spend !. -,'' and save the rest. This process will continue

with each new round of spending being * of the previous round. #s this spending

rounds continues, more income is created and more expenditure is induced.

This process will end when an extra !." million saving is generated which is e/ual to

the initial rise in government expenditure, then income will no longer be rising as a new

e/uilibrium income level is achieved. The total national income can be calculated using

the formula.

0 & "1$%! x 2I & "1'.x"& !3million

Therefore, multiplier (4) & 3 and income (0) increases from !. " million to !. 3

million as a result of an increase in government spending by !. " million.

In conclusion, an increase in investment by the government may lead to an increase in

national income as explained above.

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Comparison of two methods of calculating GDP

56% is a measure of the value of output of goods and services produced by an economy

over a period of time. The income approach measures the national income by adding the

total income generated. The expenditure method measures national income by adding the

expenditures needed to purchase all the final goods and services.

The expenditure approach consists of four parts.

The personal consumption expenditure(), the government expenditure on goods and

services (5),the gross private domestic investment (I) and net exports (78 $). The

personal consumption expenditure consists of expenditure on durable goods and services.

The government expenditure on goods and services consists of expenditure by the

government departments on goods and services. These may include consumer or capital

goods.

5ross domestic investment fall in categories9 that is, plant and e/uipment, and changes

in inventories. esidential construction is also included as an investment because it is

built to gain income.

%lant and e/uipment is the construction of factories, warehouses, stores and other non8

residential structures.

hanges in inventories are the changes in stoc:s i.e. goods that are stoc:ed up and not

used in the production process or consumed. # negative would show a disinvestment

while positive would mean an investment. net export is the value of total exports minus

the value of total imports.

The addition of all these would give 56% at mar:et prices as shown below.

; %ersonal onsumption

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on the use of capital, the interest received by households, the rent earned by the use of

land, farms and houses, the gross corporate profits including those profits earned by the

sole proprietorship, partnerships and producers co8operatives gives the total income

earned by the country at factor cost. The addition of profits made from government

activities minus transfer payments, social security and unemployment benefits. This type

of personal income is not earned from doing wor: or services. !toc: appreciation is

subtracted because if there is an increase in the general price level the value of stoc:s

rises without a real increase in output. The total of these values give 56% at factor cost.

The main difference in the two methods is in their part in the circular flow of income. In

this flow, all output is e/ual to expenditure, which in turn will be e/ual to income. The

expenditure method is on the spending side of the flow whereas the income method is on

the receiving side of the flow. The second difference is that the expenditure method gives

56% at mar:et prices, whereas income method gives 56% at factor cost right away.

The income method also has a serious problem of double counting. This is due to transfer

payments which are payments to no wor: done. #s a method, all transfer payments are to

be excluded.