National income

A) The circular flow of income


Circular flow of income


National income measures the total value of goods/services produced in one year. The circular flow of income can be shown in the diagram above. Households supply firms with factors of production (the main one being labour) which are then used to make goods/services. These goods/services are then bought by households and firms spend this money on factor incomes such as wages, rent, interest and dividends. Throughout the circular flow there are a number of injections (which lead to a multiplied expansion of output) and withdrawals. Both of these concepts will be covered later on in the topic of national income (topic 2.4).


B) The distinction between income and wealth

Income is seen as a flow of money, whereas wealth is seen as a stock of assets. For example, when consumers buy goods/services from firms, that money is then spent by the firms on wages and dividends (which are handed out to shareholder) i.e. the money continues to flow round the economy as one person’s spending is another person’s income. On the other hand, wealth is a stock of possessions/assets that are owned by consumers, such as property, shares, savings and pensions. Wealth can be measured at a particular point in time, whereas income is normally received weekly or monthly. In order for a consumer to increase their future wealth, they will have to sacrifice some of their current consumption to invest in such assets named previously; this can be seen as the opportunity cost of increased future welfare. Although income and wealth are different, wealth often generates income in the form of interest payments, dividends, pension schemes etc.