NATIONAL INCOME

Definition:
National Income is the measure of the money value of goods and services which are produced in
a country over a period of time usually one year. In calculation of national income goods and
services are put into consideration and both do matter equally. National Income is measured in
monetary terms, however, the interest is in the value of commodities produced and not the
money itself.
Concepts of National Income
1. Gross Domestic Product (GDP)
Gross Domestic Product is the market or money value of all final goods and services produced
within a country. That is the goods and services produced domestically by both Nationals and
Foreigners living within that country.
GDP = C + I + G
2. Gross National Product (GNP)
This is the measure of the money value of all goods and services produced by nationals of a
county living within the geographical boundaries of a country and abroad.
GNP = C + I + G + (X – M)
Where (X – M) is Net income from abroad.
3. Net Domestic Product (NDP)
This is the measure of money value of goods and services produced within a country by both
Nationals and non nationals less Depreciation
NDP = GDP - Depreciation cost.
4. Net National Product (NNP)
This is the income received by nationals in a country both within and outside the country less
indirect taxes and Depreciation.
NNP = GNP – Depreciation cost – indirect taxes Or
NNP = NDP + Exports – Imports
Net National Product measures Aggregate Net output of the quantity of goods required to
replace capital that wears out during the year.
5. Disposable Income
This is the income that remains with an individual after removing personal taxes and other
compulsory payment such as:- PAYE, NSSF etc.

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 6. Per-capita Income

This refers to the income per head. That is it is the average income earned per person in a
country.
Per capita income = Total National income
Total population.

7. Consumption Per Capita. This refers to average consumption per head.

8. Net Property income from Abroad

This is the Net flow of income of nationals with resources abroad less what the foreigners have
invested in the country.
Income Per Factor
This is the average income earned per factor.
Income per Factor = Total National income
Total Number of effective Labour

DETERMINATES OF NATIONAL INCOME

Economic and non economic factors determine the size and composition of national income in a
country. The factors includes:-
The level of investment: the level of investment both domestic and foreign will determine the
level of national income. If the level of investment is high, the level of goods and services
produced will be high and hence a big national income and vice-versa.
Availability of Natural resources: The size of national resources available and the level of their
exploitation determine the size of a country’s national income. If these resources such as fertile
soil, water, minerals etc. are well utilized then the level of national income will be high than
where the available natural resources are not well utilized.
The size and quality of labour force (human resource): If a country has a bigger size of high
quality or skilled working population then National income is likely to be high than where the
quality and size labour force is low and poor.
The size of capital stock: Capital in form of machinery and equipment available will assist other
factors of production which will lead to a big national income through massive production and
vice versa.
Stable Political Conditions: If there is political stability in the country that is no wars, strikes
etc with good governance, the level of economic stability will be increased and therefore the
national income will be high. In a situation of uncertainty investors are reluctant to invest in
risky enterprises hence low National Income figures.

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Institutional Factors Prevailing in the Economy: This refers to cultural and religious
institutions. If People have backward beliefs, National Income will be hindered but if they have
positive beliefs to production, willing to work, the level of National will be high.
Population growth rate: where the population growth rate is low, the size of the National
Income will be high because a low population growth rate enables a country to save and
accumulate capital than where population growth rate is high.
Availability of Market and its size: A Country that has a large domestic and external market
will have a high size of National Income and vice versa.
The level of monetization
The level of specialization and production
Availability of Foreign loans and resources
Availability of entrepreneurs in the country
The level of industrialization.

Uses of National Income Figures

1. Useful for economic planning: NY figures form the basis for formulating and
assessment of economic policies. From National Income figures we can get the level of
employment, the level of income, the level of savings and plan accordingly.

2. Identification of major Economic Activities: National Income figures help government

to determine the major activities or sectors of the economy since it shows all the
contribution by various sectors.

3. Comparing Economic Performance of a country over time. NY figures provide

useful information and indicators about the economic performance of country over time.
By establishing the annual growth rate, a country can discover whether the economy is
improving or declining over time.

4. Determining the Extent of dependency. National Income figures are important in

establishing the level of international transactions and the degree to which an economy
depends on other economies in certain sectors.

5. Comparing the standard of living: National Income figures are used to compare the
standard of ling between and among countries in the globe.

6. Income distribution: National Income reveals the distribution of income between

individuals and regions of a country. This assists government in trying to solve the
problem of income inequality and imbalances.

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 7. National Income figures are used to determine the country’s contribution to international
organizations such as UNO, COMESA, ECOWAS etc. Countries which have got high
national income contribute more than those with low or little national income.

8. National Income figures give information about expenditure partners that is what people
are spending their money on mostly.

9. National Income figures can give a summary of the state of economy at a given point in
time that is, can show the size and structure of the population.

10. The mode of resource allocation e.g. in health, education etc.

CIRCULAR FLOW OF INCOME

This is a pattern of the flow of expenditure on output and factor services passing between
domestic firms and domestic household sectors so as to illustrate the similarity in the 3 (three)
methods of measuring National Income. It shows the flow of resources and commodities and the
flow of expenditure and incomes.
Assumptions
The circular of income assumes;
1. A closed economy where there is no foreign trade and no government intervention in the
allocation of resources.
2. A simple economy of only two sectors that is firm sector and house hold sector.
3. The household does not hold any incomes.
4. The firm is the producing sector and house hold the consuming sector.
5. The firm sells all its produce to only the households.
6. The households own factors of production.
7. The firm hires factors of production from the households.
In a closed economy where there is no government intervention the circular flow of income
would apply s below:
Expenditure/payment on FOP (1)

FOP (2)
Y

f O=Y
House holds

Goods and Services (3)

Receipts from Sales and services (4)

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 A Closed economy is an economy which does not interact with other economies. From the
above Figure:-
i. Firms buy FOP from households (2) and pay for these FOP (1). Firms use the Factors
of Production to produce goods and services which they sell to households (3). In turn
households pay for these goods and services (4)

ii. Arrows (2) and (3) show real flows. The flow of factors of production and
commodities respectively.

iii. Arrows (1) and (4) shows monetary or financial flows that is the flow of expenditure
and income respectively.

iv. The value of goods and services is equal to households expenditure on them
(expenditure approach).

v. Receipts received by firms from sale of goods and services are spent on buying
factors of production. These receipts constitute income in households (income
approach).

Therefore, the three (3) approaches should give equivalent results if there are no errors.

Approaches/methods of measuring National Income.

Income Approach.
In this method we measure the income received by various sectors of the economy which will
contribute to the production and services.
We add up all the incomes that are earned by individuals e.g. salaries, wages, interests, profits,
commissions, rent etc. when adding up incomes of individuals one should avoid double counting
of transfer payments. That is transfer payments are not included in the calculation and
compilation of national income figures.
We also add public income (government). It includes profits from public enterprises and
property from government. The sum got is the Gross Domestic Product. When Net property
income from abroad is added to GDP we get Gross National Income (GNY). When depreciation
is subtracted we attain Net national income. This method presents national income in terms of
incomes earned by factors of production engaged in producing the output. It always gives
national income at factor cost.
Problems faced when calculating National Income using Approach.
1. Lack of information: Individuals have got different sources of income not known to the
public. Many people are self employed and not willing to declare their incomes.
2. Double counting: There is a tendency for people to include transfer earnings. This lead to
the problem of double counting which arises from failure to exclude transfer
earnings/payments.

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 3. It is difficult to calculate income from abroad.

4. It difficult to adjust capital gains from genuine income. That is Assets do gain value with
time as a result of changes in prices and these gains should not be included when
calculating National Income.

5. Difficulty in measuring depreciation allowances: It is difficult to get the rate at which

these machines are wearing out.

6. It is difficult to determine the bounds of production.

Expenditure Approach
In this approach we add up all expenditure on final goods and services during the year. The
expenditure must be on final commodities to avoid double counting. We concentrate on the
components of final demand which are; consumption + investment + Net exports – imports + Net
property income from abroad. What is attained is GDP at Market price.
Problems Faced when Calculating National Income using Expenditure Approach
1. Lack of information about consumption and investments of people.
2. Double counting arises because of difficulties in distinguishing between expenditure on
final products and inter-mediate products.
3. It is difficult to determine government expenditure on transfer payments.
4. Expenditure on imports is not known, what we spend within the country is also not
known.
Product/Output Approach
This is the most direct method of calculating National Income. We sum up the value added on
output by all sectors per year that is National Income is measured by taking the summation of all
the total monetary contribution made by the various sectors or individual enterprises in the
economy. Intermediate goods and services should be excluded and final goods be considered. It
should be noted that each time something is produced and sold, its value is equal to consumers
expenditure which is received by those who contributed to its production. The same value is the
result of value added on output at successive stages of production. Only the value added should
be used in the calculation of National Income
Problems faced when using the Product Approach
1. Problem of double counting
2. Lack of information about the total output of a country.
3. Problem of inventories of goods which are produced during the current year but not sold
in that year (stock of unsold goods). it is not certain for the rate at which they should be
valued.
4. It is difficult to determine the value of subsistence production.
5. The boundary of production cannot easily be determined.

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Problems Encountered when Measuring/ Calculating National Income of a Country
The problems faced when measuring National Income in Low Developed Countries are either
conceptual or statistical. Conceptual problems are those that are related to the subject matter of
National Income and relate to the determination of items to be included or excluded in the
National Income figures. Statistical problems on the other hand are those that are faced during
the process of data collection.
The general problems include the following: -
1. Inadequate information: lack of statistical information and where it is available is not
adequate enough.
2. Double counting: this is the counting of items more than one because of the difficulty to
distinguish between final goods and intermediate goods etc.
3. Boundary of production: it is difficult to determine which goods or activities should be
included in National Income statistics.
4. Price charges: prices are always changing and their change affects the value of National
Income such that when there is inflation National Income also increases and vice versa. It
is difficult to adjust and define the effect of inflation and deflation.
5. It is difficult to estimate depreciation so as to determine the Net income because different
firms use different methods to calculated depreciation.
6. Inadequate skilled manpower: In Low Developed Countries (LDCs) there is lack of
sufficient manpower to do the exercise. There is a shortage of qualified and experienced
personnel to collect the data effectively.
7. Omitted market transaction: In an economy a large number of transaction take place in
the market but not all those are included in calculating Gross National Product (GNP). It
is only those that results from productive economic activities which are relevant when
compiling National Income.
8. Determination of National Income from abroad: It is difficult to determine the Net
Income from abroad because import and export trade are carried out buy many people or
groups with little data available to verify the amount imported and exported by private
individuals. It is also difficult to distinguish between smuggling and illegal international
trade.
9. Timing of production: It is difficult to determine the time of production during the year
e.g. second hand clothes are not included when calculating National Income because it is
difficult to determine when they are produced /brought.
10. Subsistence production: there are some goods and services which people prefer to
produce for their own use. It is therefore difficult to get the value of such output which is
not offered to the market.
11. Inadequate facilities: facilities like computer and other Information Technology
equipment to collect and analyze data are not sufficiently employed.
12. It is difficult to evaluate the value of government utilities.
National Income and Standards of Living
Standard of living refers to social and economic welfare in a country in a given period of
time. It is the level of welfare of an individual or individuals in a country as determined by
the quantity and quality of goods and services that are able to enjoy. This can be determined
by:

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  The level of Nutrition.
 The level of housing, clothing and personnel hygiene.
 Level of life expectancy.
 Infant monetary rate.
 The degree of freedom.
 The amount of leisure time.
 The quality of medical care.
Factors that influence or determine people’s standard of Living
1. Price level of goods and services: when the general price level is low the standard of
living is high and vice versa.
2. Degree of freedom: lack of freedom leads to a low standard of living while a high degree
of freedom leads to high standard of living.
3. Availability of time for leisure: when people are over worked in a country without
having time for leisure Standard of Living is likely to be low but if there is enough leisure
time the standard of living is likely to be high.
4. Availability and level of medical care/health services: where the health services are
readily available, the standard of living is likely to be high and vice versa.
5. Political climate prevailing in other country: Political instability a country leads to low
standard of living, During political instability people’s lives and property are in damage
which negatively affect their quantity of life. While political stability leads to high
standard of living.
6. Quality of goods and services produced: production of better quality products leads to
high standard of living while poor quality commodities negatively affect people’s health
and quantity of life.
7. Nature of goods produced in a country: where a country produces more of capital
goods at the expense of consumer goods, the standard of living is likely to be low
because capital goods do not directly contribute to people’s welfare. But where a country
produces more of consumer goods then standard of living is likely to be high.
8. The level of education and skills: high levels of education and skills lead to high
standard of living. With high education and skills most people in the country can have
access to jobs and incomes which can use to purchase foods and services while low level
of education and skills leads to low standard of living because people are unable to get
lucrative employment.
9. Distribution of income: income inequality results into low standard of living. When
incomes are evenly distributed people can purchase enough goods and services and vice
versa when incomes are unevenly distributed.
10. The level of income in the country: High income level leads to high standard of living
and vice versa.
11. High rate of unemployment: A high rate of unemployment leads to low standard of
living and vice versa when the most population are employed.
12. The availability and mount of foreign aid: If a country receives foreign aid on
favorable terms the countries material standard of living will be high and vice versa.
13. The level of technological advanced: The higher the level of technological advancement
the higher the standard of living and vice versa.
Causes of Low Standard of Living

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 1. High general price level.
2. Low level of income.
3. Low educational levels and skills.
4. High levels of income inequality.
5. Political instability.
6. Lack of freedom.
7. Long/poor working conditions.
8. High capital stock.
Per Capita income as an index for Standard of Living
1. The size of monetary (normal) national income of the country.
2. The population level of country in a given period of time.
Advantages
1. Per capital as an index of standard of living is convenient because it is easy to calculate.
2. Data is available most countries have information or data about their population and
National Income and National Income figures.
3. Per capita income is reasonably good indicator of social economic structure of societies
cost of pollution, smoking, swap proclamation etc. (environment degradation).
NB: The higher the per capital income the high the standard of living and vice versa.
Limitation of using per capital Income for measuring the standard of living in the Country
1. It does not take into account leisure time which contributes to welfare per capita income
may be high in a country where people work hard and fore go leisure which may be on
top of their scale of preference.
2. It does not consider the goods produced as it may be high, the country which produces
capital goods which does not improve welfare directly.
3. It ignores the price levels in a country. A high price level of goods and services implies a
low standard of living despite income per capital being high.
4. Income per capital ignores the distribution of incomes in the country. A country may
have high income per capital figures when income is in the hand of a few
individuals/people while the majority of the production is suffering.
5. In most LDCs there is inaccurate population figure and therefore figures for per capita
income are un reliable.
6. It does not show the degree of figures members have in society and self-esteem.
7. Per capital income does not show the level of employment yet per capital income and
National Income may rise due to intensive methods of production which will not increase
the level of employment and therefore the standard of living is much low.
8. Per capita income does not focus on the social factors which influence the standard of
living [Link], Accidents, industrial population etc.
9. Per capita Income may be low because of a large substance sector which is not included
in the National income estimates.
10. Per capital income figures have social services like education, health and transport.
11. It ignores the effect of climatic factors.
12. It ignores the distribution of goods and services.

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Limitation of using Per Capital Figures for comparing the Standard of Living
1. Differences in types of goods produced: different types of goods yet National Income
Figures that show per capita income may be high in a country that produces capital goods
which do not improve the welfare directly.

2. Differences in income distribution the nature of income distribution varies between

countries whereby in some countries there is equality in income distribution unlike other
countries with high level of income inequality may mislead that with the average person
who is well of.

3. The level of accuracy when calculating National Income differs from country to country.

4. The structure of prices differs greatly in different countries.

5. The level and size of substance sector differs from one country to another.

6. Different countries incur different costs because of different reasons e.g. Uganda Land
locked country incurs more transport cost than Kenya which has cost line.

7. Food and nutrition standards aren’t the same.

8. Difference in Test and preference: tests of people in different countries differ because of
age, tribe, culture, religious differences etc.

9. Different countries have different requirements.

Income Distribution and income inequality

This refers to the distribution of goods and services (private or public) among various social
groups.
Income inequality refers to economic distance or gap that exists between that exists between
various groups of people individuals. Or regions in an economy i.e. it is the economic distance
between the very poor and very rich.
Causes of Income Inequality
Income inequality may be among different social group or even among people, in the same social
group.
Historical back ground/factors: The traditions of ethnic groups like the kingship where the
royal family is favored in terms of land, employment and education.
Un even regional distribution of resources: The imbalance in the regional natural resource
endowment implies people in places with a lot of resources like mineral, goods soils, water
bodies etc. have the advantage of earning high income than areas without these.

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Differences in Education and Training: The more educated or trained the worker is the more
he can be paid and vice versa.

Access to finance and credit facilitates: people who have easy access to cheap finances like
loans or grants develop faster than others and tend to have high income.

Effects of inflation: During inflation salaried people became poorer while the business people
become richer.

Unequal distribution of social and economic infrastructure: People who come from areas
with concentration of infrastructure like schools, hospitals, good roads, factories etc. get higher
incomes than those from areas that lack such infrastructures.

Age differences. Old people who have accumulated more wealth over time have higher income
than young ones

Effective of regressive tax system taxes have more impact on the poor than the rich.

Differences in employment i.e. some jobs bring in more money than others.

Political favoritism. People who are politically favored to earn more income in just the same way
apolitically favored region are likely to develop faster than the rest.

Discrimination. Discrimination based on sex, age, religion e.g. women are preferred in some
highly paid jobs e.g. personnel secretaries

Extended families led to low saving.

The Effects of Income inequality positive effects

1. Encourages hard work due to demonstration effort where by every person works had to
be rich or prosperous like his neighbor.
2. It uses government revenue when the rich are taxed highly to rise more revenue.
3. The rich people have high marginal propensity thus the level of saving rises in the
economy.
4. Leads to increased investment by rich people in the economy who have sufficient
resources and low marginal propensity to consume.
5. There is a trickle-down effect through the development of the areas where the rich people
stay or come from.

Negative effects
1. It leads to minimum economic welfare of some groups of people because of absolute
poverty i.e. in ability to purchase basic needs.

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 2. It reduces the chance of participation of a majority in production since money will be in
hands of a few rich.
3. It leads to capital outflow especial when the rich are non-citizen who always repatriate
their earning to their own countries.
4. It contributes to slow rate of the economic development especially if the rich are fewer
than the poor.
5. It encourages the development of dualism in an economy i.e. the existence of both
traditional and modern technique of production in an economy.
6. It leads to increase in rural urban migration in search for employment and better wages.
7. It leads to social disharmony which leads to political instabilities.
8. It leads to misallocation of resources when demonstration effect falls.
9. Increased rate of social crimes e.g. thuggery, murder etc.
10. It has led to development of social differences and poor treatment of others.
11. It reduces aggregate demand i.e. purchasing power of the community.
12. It complicates the making of appropriate plan for national development due to the
inconsistence of these two categories of people i.e. the rich and the poor.

Way of reducing Income Inequality

1. Fiscal Policy
The rich should be taxed more than the poor. The government should provide the poor with
inputs at subsidized prices and unemployment benefits should be given to those who are not
employed.

2. Both social and economic infrastructure should be allocated to backward regions

3. Rural development policy should be design to increase agricultural and industrial
development in rural areas so as to reduce the income inequalities both the rural and
urban people.
4. Prices of agricultural products should be increased to avoid the rural(poor) with enough
income and encourage then to invest.
5. Education policy: there should be free and quality education especially for the children of
the poor on job training can also lead to improvements in skill and reduction in
unemployment.
6. Resources should not be distributed on political grounds. There should be justice in the
distribution of resources and allocation for contracts.
7. The government should ensure political stability in the whole country.
8. Land reform policies i.e. settlement schemes should be established.
9. Mobility of labor should be encouraged by creation of more job opportunities and
establishment of a cool political climate as well as incentives for investment.
10. Legislation of wages by government: government should set minimum wages so that
employers do not pay below that wage and the maximum wage to avoid payment of
wages about that wage level. This can help to close the gap between the poor and the
rich.
11. The income redistribution policy should therefore be a package of short term, medium
term or long-term policies that are geared towards reducing income inequality depending
on how the phenomena had been caused.

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The principle of the multiplier:
The multiplier refers to the ration of change in income to the initial change in expenditure that
brought it about. It is the number of time by which an initial change in expenditure is multiplied
to give a final change the level of income. It is given as:

Change in Income
__________________________ DY
Change in injection Expenditure DE

According to the multiplier concept an increase in investment will lead to increase in expenditure
which will…………………..

The concept of the multiplier is based on the two concepts of:

1. Marginal propensity to save
2. Marginal propensity to consume

The marginal propensity to consume refers to that part or fraction of additional income a
consumer is willing to spend on consumer good. While the marginal propensity to save refers to
that part or fraction of additional income that the consumer is willing to set aside as saving.

Example
If an employee has received salary increase of 10,000 in a month, he made choose to spend 8,000
on the purchase of consumer goods and put aside 2,000 on his bank Account as a saving.

If the above figures are expressed as fraction, the following figures may result.

The coefficient of MPC = 8,000 = 8 = 0.8

10,000 10

The coefficient of MPS = 2,000 = 2 = 0.2

10,000 10

MPC + MPS0.8 + 0.2 =1

Illustration of the Multiple Process

If there is increase in investment in spending in an economy, the whole of these will be incomes
to factors of production in the projects that have had this investment some of the incomes may be
spent on the purchase of consumer goods and the res may be saved thus if consumer goods are
produced, money spent on them will be income to those produced them. In turn the people will
also spend a proportion of this money income and save the reminder. This process of receiving
incomes and spending part of it and saving the balance will continue on and on in an economy.
Hence the initial amount of investment spending will be multiplied several times.

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 Example
Assume the government invests 1,000,000/= in a new agricultural project with students of UCT
who have the MPC of 0.8 (80%) and the MPS of 0.2 (20%) we would have the following pattern
of expenditure and incomes.
1stStage
Initial investment 1,000,000
Increase in income 1,000,000
Increase in consumption 8,00,000
Increase in saving 2,00,000
2nd Stage
The increase in consumption of 800,000 will give an increase of 300,000 to second group of
people employed in the production of own good.
Thus, increase in income = 800,000
Increase in consumption = 640,000
Increase in saving = 160,000

3rd Stage
The increase in consumption of shillings 640,000 will again become the increase in incomes to
the third group if people in stage two. This process continues until the initial investment leads to
a greater increase in total income.
Therefore, the working of the multiple process will be:

Stages/Periods Increase in Income (shs) Increase in consumption (shs) Increase in saving (shs)

MPC = 0.8 MPS = 0.2

1st Lot 1,000,000 800,000 200,000

2nd Lot 8,00,000 640,000 160,000

3rd Lot 640,000 512,000 128,000

4th Lot 512,000 409,600 102,400

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It can therefore be seen that the only shs, 1000,000 has been multiplied several times thus
leading to a total of shilling 5,000,000 due to the working of th multiplier. The formula for
calculating the coefficient on the size of the multiplier is 1
1 – MPC
The multiplier = 1 = 1 = 5 times
1 – 0.8 0.2
Total increase in incomes = Initial income X Multiplier
= 1,000,000 x 5 = 5,000,000/=

Types of Multiplier
1. Income Multiplier
2. Investment Multiplier
3. Government Multiplier
4. The Tax Multiplier
5. The export multiplier
The Accelerator Concept
The accelerator principle is the magnitude by which a change in consumption expenditure brings
about a change in the level of investment.
Accelerator = Change Investment
Change in Consumption
That is; it is the multiple by which new investment increases in response to changes in
consumption. The accelerator is based on the fact that the demand for some capital goods is
derived from the demand for costumer goods which the farmer produces.
Limitations of the Accelerator Principle
The accelerator principle has been criticized for its rigid assumptions which ted to limit its
smooth working. The following are some of the limitation.
1. Variations in capital output ration. The concept is based on a presumed constant
capital ratio. However, this ratio is never constant because constant innovations and
invention in the technique of production leads to increase in output per unit of capital
equipment.

2. Situations of full employment. The principle assumes that resources are available and
elastic enough to be employed to the capital close industries to enable them to expand.
However, this is only possible when there is unemployment in the economy. Once the
economy reaches the full employment level the capital close industries fail to expand due
to non availability if resources and this limits the working of the accelerator principle.

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 3. Existence of excess capacity. It is assumed that there is no excess or un used capacity in
the education units. However,if some units are not working to their full capacity are not
lead to increased demand for mew capital goods and thus limiting the working of the
accelerator principle.

4. Provision of expansion room in initial investments. It is assumed that future increase in

demand for consumer goods are not anticipated and planned for in initial capital
investment. However if anticipated future demand is provided at the initial capital
investment stage such demand would not lead to induced invest and the accelerator effect
will be zero.

5. Lack of cheap credit. It is assumed that there is always inelastic and ready supply to
credit so that when there is induced investment as a result of induced consumption, cheap
credit is available for investment in capital goods industries. However, if cheap credit is
not available in sufficient quantities, the rate of interest will be high and investment
capital goods industry will be low as a result the acceleration principle will not work fully
as expected.

6. Inflation and Deflationary gaps. The gap occurs when an economy attains full
employment before attaining equilibrium level of National Income and the resources are
not sufficient to meet the aggregate demand.

7. This is a situation where the aggregate expenditure exceeds the maximum level of
optimum which results into upwards pressure on prices. It is where aggregate demand
exceeds aggregate supply at full employment level and national income.

NB: It’s when national income is at equilibriumlevel which is higher than one where resources
are fully employed.
Illustration
Expenditure

Income
YE = Equilibrium level of Y
AB = Inflationary gap

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YI = Full employment level of Y

Inflationary gap implies that economy suffers from high aggregate demand and maximum
attainable optimum is low this means the prices persistently rises.

Causes of Inflationary Gap

1. Mass exploitation of resources
2. Realized invest is less the actual invest deficit budgeting
3. Deduce in taxation rates
4. Income rise in money terms
Pleasures to Close
1. Increase in taxation to reduce disposable income for aggregate demand.
2. Reduction in government expenditure
3. Discourage export to increase availability of goods in local market.
4. Tight income and wage policies
5. Price control measures
6. Restrictive monetary policy
7. Increased importation
8. Conceive incest policies to attract investors
9. Sell of government securities to the public
10. Have a balanced budget.

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DeflationaryGap
This is a situation where aggregate expenditure falls below the level required to produce a level
of national income which would ensure full employment of resources.
This is a situation where aggregate supply exceeds aggregate demand at full employment level of
resources. All goods and services produced cannot be absorbed by the consumers.
The economy attains full equilibrium at a level which lower the full employment level of
national income.

Expenditure
E = Y axis
Deflationary gap
EADD

Income

Stage – flation is a situation where there is co-existence of high levels of

At this stage some resources are idle and hence aggregate demand must be increased from AD to
E so that the economy is in equilibrium at full employment.
Measures to close a deflationary gap
1. Expansionary monetary policy increasing money to circulation that would enable people
buy goods and services thus increasing aggregate demand
2. A lose fiscal policy. Reducing taxes and increasing government expenditure.
3. The wage policy. Through increasing wages, when people’s wages increase aggregate
demand also rises.
4. Encouraging exports and discouraging imports.

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