Chapter 8

NATIONAL INCOME
Limitations of GNP
1. It does not show the
allocation of goods and
services among the members
of society
 Limitations of GNP

2. GNP Accounting in less developed

countries is understated.
 Limitations of GNP

3. The evils of economic growth are

not reflected in the GNP.
 Limitations of GNP
4. GNP only measures the number of
goods and services, but not the
quality.
 Limitations of GNP
5. Incomes or products from illegal
sources are not included in the GNP.
 Consumption
The amount of money spent on
goods and services which yield direct
satisfaction
It is the biggest of the major
components of expenditure on
output
 Savings
That part of income which is not
consumed
 Formulas
Y=C+S
S=Y-C

Where:
Y = income
C = consumption
S = saving
 Factors Influencing Consumption
1. Distribution of National Income
 Comparison
Uneven Distribution Even Distribution
Y C S Y C S
400 000 200 000 200 000 200 000 100 000 100 000
300 000 100 000 200 000 200 000 125 000 75 000
150 000 75 000 75 000 200 000 150 000 50 000
75 000 50 000 25 000 200 000 175 000 25 000
50 000 25 000 25 000 200 000 200 000 0
25 000 15 000 10 000 1 000 000 750 000 250 000
1 000 000 465 000 535 000
 Factors Influencing Consumption
2. Rate of Interest
 Factors Influencing Consumption
3. The desire to hold cash
 Factors Influencing Consumption
4. Price Level
 Factors Influencing Consumption
5. Population
 Factors Influencing Consumption
6. Income
 Factors Influencing Consumption
7. Taxes
 Factors Influencing Consumption
8. Attitudes and Values

Thrifty vs. Extravagant

 Consumption Function

The functional relationship between

income and consumption
2 Ways to Analyze the Relationship Between
Income and Consumption

1. Average Propensity to Consume (APC)

the fraction of all income spent on
consumption
2. Marginal Propensity to Consume (MPC)
the ratio of the increase in the
consumption to the increase in income
that caused it
 Formula

C
Y

C = Y , the answer is 1
C < Y , the answer is less than 1
C > Y , the answer is more than 1
Given Computation Answer
C = 1 000 1 000 1.00
Y = 1 000 1 000

C = 500 500 0.50

Y = 1 000 1 000

C = 1 000 1 000 2.00

Y = 500 500
 Investment
Expenditure on new capital goods
 Determinants of Investment

1. Marginal Efficiency of Investments

(MEI) or Return on Investments
(ROI)
2. Interest Rate
Other Factors Affecting Marginal Efficiency of
Investment (MEI)

1. Population
2. Price Level
3. Technology
4. Peace and Order
5. Government Policies
 Multiplier Effect

Multiplied effects of investments on

income
 Multiplier
The ratio of the increase in income to the
increase in investment

K = Y = 500 = 5
I 100
Where:
K = Multiplier
Y = Increase in Income
I = Increase in Investment
 Accelerator Effect
The effect of consumption on
investment
 Paradox of Thrift

The attempt of consumers to save

more will reduce saving.
- John Maynard Keynes