2.4.1 National Income

This Edexcel economics study note covers national income.

The Circular Flow of Income

The circular flow of income is a model that describes how money moves within an economy. It illustrates the flow of goods, services, and money between different sectors.

Key Components:

• Households: Provide factors of production (labor, land, capital) to firms and receive wages, rent, and profits in return.
• Firms: Produce goods and services, paying households for their factors of production and receiving revenue from selling products.
• Government: Collects taxes from households and firms, and spends on public services and welfare.
• Financial Sector: Facilitates saving and investment by households and firms.
• Foreign Sector: Engages in trade with the domestic economy through exports and imports.

Flows in the Model:

• Real Flow: Movement of goods and services (e.g., labor, products).
• Money Flow: Movement of money (e.g., wages, consumer spending).

Leakages and Injections:

• Leakages: Savings, taxes, and imports, which remove money from the circular flow.
• Injections: Investment, government spending, and exports, which add money to the circular flow.

Real-World Example:

• In the United States, households supply labor to companies like Apple and receive wages in return. Apple uses these labor services to produce iPhones, which they sell to consumers globally, generating revenue.

The Distinction Between Income and Wealth

Income:

• Refers to the flow of money received, typically measured over a period (e.g., monthly or annually).
• Sources include wages, rent, interest, and profits.
• Example: A teacher’s annual salary is a form of income.

Wealth:

• Refers to the stock of assets owned at a given point in time.
• Includes physical assets (real estate, cars) and financial assets (stocks, bonds).
• Example: Ownership of a house and shares in a company represent wealth.

Key Differences:

• Measurement Period: Income is measured over time; wealth is measured at a point in time.
• Nature: Income is a flow concept; wealth is a stock concept.

Real-World Example:

• An individual earning $50,000 per year from their job has an income of $50,000. If they own a house valued at $300,000 and stocks worth $50,000, their wealth totals $350,000.

Glossary

• Factors of Production: Inputs used in the production of goods and services (e.g., labor, land, capital).
• Leakages: Non-consumption uses of income (savings, taxes, imports) that remove money from the economic cycle.
• Injections: Additions to the economy's circular flow (investment, government spending, exports) that introduce money into the cycle.
• Stock Concept: A measurement at a particular point in time (e.g., wealth).
• Flow Concept: A measurement over a period of time (e.g., income).

Key Economists

• John Maynard Keynes: Revolutionized economics with his work on income and output determination, advocating for government intervention to manage economic cycles.
• Simon Kuznets: Developed methods for measuring national income and its components, leading to the creation of the GDP.
• Arthur Pigou: Made significant contributions to welfare economics and the theory of national income.

Possible Essay-Style Questions

1. Discuss the implications of leakages and injections in the circular flow of income model for a country's economic stability.
2. Compare and contrast the concepts of income and wealth, and analyze their significance in understanding economic inequality.
3. Evaluate the contributions of John Maynard Keynes to modern macroeconomic theory, particularly in the context of national income determination.