National income equilibrium

What is national income?

A country's national income is the total amount of new 'final' goods and services produced over a period of time - usually measured annually and quarterly.

To be included in calculations of national income, transactions must 'add new value' - hence, not all transactions are included. For example, purchasing a 'used' three-year-old (second-hand) motor car in 2021 does not add value to national income in 2021. If it is three years old, then the initial purchase in 2018 added to national income then. If it is added again it will create the problem of double counting.

Also, transactions that add to national income only relate to 'final' transactions - in other words, the 'last' stage in the production and distribution process. Again, there is a potential problem of double counting - counting all the transactions between suppliers of components (the 'intermediate stages'), and the final sale to the customer would include the value of the components twice.

National income is a 'flow' not a 'stock'

National income is the measurement of the output produced in the current period (such as 2021), and not the accumulation of transactions in previous years. National income accounts measure the 'flow' of new and final goods and services, and not the 'stock' of previously traded assets. The value of all previous assets is called 'national wealth'.

One reason why economists refer to national income much more than wealth is that wealth is very difficult to measure, much is 'hidden' from immediate measurement, and, for some assets, market values are very volatile, and hence difficult to determine.

National income equilibrium

National income equilibrium refers to a situation when the level of national output (commonly measured as Gross Domestic Product - GDP) is stable over time.

There are two ways to understand GDP equilibrium - firstly, a stable GDP will occur when the aggregate supply (AS) in an economy is exactly matched by aggregate demand, (AD) and secondly when the injections of new spending into circular flow of income (J) equal the leakages or withdrawals (W) leaving the circular flow of income, hence:


GDP (Y) occurs when: AD = AS; and
W = J

National income is commonly modelled in terms of the price level, which means using the aggregate demand-aggregate supply model (AD-AS model). This means that there will be a price level which equates aggregate demand and short run aggregate supply.

Example

We can see that aggregate demand is inversely related to the price level, and aggregate supply is positively related.

national income equilibrium

Equilibrium is a Y=100, which is where AD equals AS, at 250 bn.

national income equilibrium

Changes in national income

Equilibrium national income (or ‘Y’) can change following a change in AD or AS (or in J or W). Assuming a constant price level, AD can shift to the right, which is an increase, if a component of AD increases. This could include increases in household consumption, investment, government spending or exports.

Video on national income equilibrium

Each of these is determined by many factors:

For example, household spending is affected by real wages, unemployment levels, consumer confidence and interest rates.

Lower interest rates, and income tax, and higher wages could all increase AD. AD can shift to the left - a decrease, if a component of AD decreases. Higher interest and tax rates, and lower wages are likely to reduce AD.

national income equilibrium

On the supply side, AS can increase if there is an increase in productivity, a fall in costs, or a rise in the exchange rate.

Conversely, AS can decrease following a fall in productivity, a rise in costs or a fall in the exchange rate. In all cases, shifts in AD or AS will have an impact on equilibrium Y and the price level.

national income equilibrium

Why does the AD curve slope downwards?


Aggregate demand

Aggregate demand and the AD curve.

Aggregate demand
Fiscal policy

How can fiscal policy influence aggregate demand?

Fiscal policy
Monetary policy

How effective is supply-side policy?

Supply-side policy

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