Good Essays
You may have already studied microeconomics, which

looks at supply, demand and prices for individual

goods. Macroeconomics looks at the bigger picture

and involves the study of the economy as a whole.

National income

Let us start by looking at a simple example - a

'two sector' economy made up of households

(consumers) and firms (producers) -and use this to

develop the idea of national income. To start with

we will ignore the impact of government policy and

overseas sectors.

Households ultimately own the factors of

production, e.g., labour, materials and capital,

and supply these factors to firms who use them to

produce goods and services. In return households

earn rewards for supplying the firms with the

factors of production e.g., wages and interest on

capital. These rewards are in turn used to buy the

goods that the firms have produced. This process

is known as a circular flow- see Figure 1.

Figure 1: Simple circular flow

From Figure 1 we can see that there are three ways

of measuring the amount of economic activity in

the economy. These are:

(a)National product/output = the flow counted at

this point represents the amount received by firms

for their total production.

(b) National income = the flow counted at this

point represents the total income received in

return for factors of production.

(c) National expenditure = the flow counted at

this point represents the total expenditure by

households on goods and services.

If it is assumed that all income is spent, then

whichever method is used the same measure of

economic activity must be obtained. Let's look at

a numerical illustration.


Assume there are two producers - a lumberjack and

a carpenter. The carpenter makes chairs each of

which needs £5 worth of wood and which he sells

for £20. Total annual sales are 10,000 chairs. The

income and expenditure accounts for the lumberjack

and carpenter are:


Purchases (wood)50






'National Product' = 200

This is the total value of the production (i.e.,


'National Income' = 40 + 20 + 50 + 40 + 10 + 5 +

20 + 15 = 200

This is the total received for factors of

production i.e., wages, interest, rent and profit

'National Expenditure' = 200

This is the total amount spent on production (i....

... middle of paper ...

...when there is

excess demand which forces up prices and factor

prices. Most governments want stable prices and

low inflation. In the UK the fight against

inflation has been a mainstay of government policy

for many years. One of the main reasons given for

this is that inflation causes uncertainty as to

future values and therefore stifles investment and

prevents growth. Certain elements of society will

be badly effected by high levels of inflation

because not all incomes rise in line with it -

those on fixed incomes suffer the most. High

levels of inflation discourage saving because of

the declining value of the money saved. In extreme

cases the function of money may break down

resulting in civil unrest, as happened in Germany

in the 1920s, or even war. In addition Monetarists

consider that inflation distorts the working of

the price mechanism and is thus a market

imperfection preventing the economy reaching full

employment equilibrium.

So governments will be aiming to achieve economic

growth while at the same time controlling

inflation at an acceptable level. However, there

are other elements to the macroeconomic balancing

act which need to be taken
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