Fundamentals of Economics

PROBLEMS OF MEASURING
NATIONAL INCOME

(1) Problems of non-monetized sector
 The existence of a large number of non-monetized
activities in these countries, especially in the
agricultural sector makes the computation of the
national income more difficult.

(2) Underground economy
 Official GDP estimates may not take into account the
underground economy, in which transactions
contributing to production, such as illegal trade and tax-
avoiding activities, are unreported, causing GDP to be
underestimated.

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PROBLEMS OF MEASURING
NATIONAL INCOME (cont.)

(3) Non-market transactions
 There are many productive works done in the economy but
they are not paid. Food grown in backyard plots, home
repairs, clothes made at home, and any other do-it-yourself
goods and services that people make or do for themselves,
their families or their friends are not counted in GDP.

(4) Problems of expertise and modern machinery
 The lack of professionals such as statisticians, researchers,

programmers and analysts is a major problem in third world

countries.

(5) Problems of double counting
 Double counting in national income will appear when both

values of final goods and intermediate goods are included.

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11

CHAPTER

DETERMINATION OF NATIONAL INCOME
EQUILIBRIUM

LEARNING OUTCOMES

At the end of this chapter, you should be able to:

 Discuss the two different approaches in the determination of
national income equilibrium

 Define autonomous and induced consumptions from the
conventional perspectives

 Discuss the Islamic consumption theory according to Fahim Khan
Islamic consumption

 Describe the investment theory from the conventional perspective,
autonomous and induced investments, from the Islamic
perspective

 Calculate income equilibrium in two-, three- and four-sector
economies

 Define and calculate the expenditure multiplier

 Illustrate inflationary gap and deflationary gap

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TOPICS COVERED

 1. Approach in determining national income equilibrium

 2. Consumption

 3. Saving

 4. Islamic consumption theory

 5. Investment

 6. Islamic Investment

 7. NIE – 2 sector of economy

 8. NIE – 3 sector of economy

 9. NIE – 4 sector of economy

 10. Multiplier

 11. Inflationary gaps & Deflationary gaps All Rights Reserved

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INTRODUCTION

 It is important to learn about and understand the
determination of national income equilibrium
because the equilibrium level will affect the level of
employment in the economy, and it is also used to
identify the rate of unemployment that occur in the
economy.

 An increase in the production of goods and services in
the economy is the result of a high equilibrium level of
national income.

 This indicates that an excessive number of resources
are being employed in the economy.

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1. APPROACHES IN DETERMINING
NATIONAL INCOME EQUILIBRIUM

According to Keynesian approach there are 2 types of national
income equilibrium APPROACH

Aggregate Leakages =
Supply = Injections
Aggregate Approach
Demand
1. AS = AD Approach 2. I = S

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APPROACHES IN DETERMINING
NATIONAL INCOME EQUILIBRIUM (cont.)

1. INJECTION (I) = I , G , X 2 components
under I = S
Injection is an approach
income that can be
A leakage is an
raised within the income received by
circular flow.
all sectors in the
Injections include economy which is not
investments, distributed within the
government
circular flow.
expenditures and Leakages include
exports. savings, taxes and
imports. A leakage

will reduce our
national income.

Fundamentals of Economics 2. LEAKAGES (S) = S , T , M
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1–7

APPROACHES IN DETERMINING NATIONAL
INCOME EQUILIBRIUM (cont.)

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APPROACHES IN DETERMINING
NATIONAL INCOME EQUILIBRIUM (cont.)

National income equilibrium diagram (AS = AD approach)

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APPROACHES IN DETERMINING
NATIONAL INCOME EQUILIBRIUM (cont.)

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APPROACHES IN DETERMINING
NATIONAL INCOME EQUILIBRIUM (cont.)

National income equilibrium diagram (I = S) approach

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APPROACHES IN DETERMINING
NATIONAL INCOME EQUILIBRIUM (cont.)

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APPROACHES IN DETERMINING
NATIONAL INCOME EQUILIBRIUM (cont.)

Recall - Circular Flow of Income Diagram

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APPROACHES IN DETERMINING
NATIONAL INCOME EQUILIBRIUM (cont.)

CONSUMPTION THEORY

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2. CONSUMPTION: AUTONOMOUS
AND INDUCED CONSUMPTION

CONSUMPTION THEORY

 Consumption also can be defined as spending by all
households in the economy on goods and services
produced within the economy. Consumption refers to the
‘planned’, ‘intended’ or 'ex ante’ consumption.

 Consumption is the main component of aggregate
expenditure.

 The most important factors which influences consumption
is disposable income.

Yd = Y + Transfer payment - Taxes
Yd = Y - T

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AUTONOMOUS AND INDUCED
CONSUMPTION (cont.)

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AUTONOMOUS AND INDUCED
CONSUMPTION (cont.)

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AUTONOMOUS AND INDUCED
CONSUMPTION (cont.)

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AUTONOMOUS AND INDUCED
CONSUMPTION (cont.)

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AUTONOMOUS AND INDUCED
CONSUMPTION (cont.)

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AUTONOMOUS AND INDUCED
CONSUMPTION (cont.)

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AUTONOMOUS AND INDUCED
CONSUMPTION (cont.)

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AUTONOMOUS AND INDUCED
CONSUMPTION (cont.)

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AUTONOMOUS AND INDUCED
CONSUMPTION (cont.)

Autonomous consumption diagram

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AUTONOMOUS AND INDUCED
CONSUMPTION (cont.)

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AUTONOMOUS AND INDUCED
CONSUMPTION (cont.)

Induced consumption diagram

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AUTONOMOUS AND INDUCED
CONSUMPTION (cont.)

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AUTONOMOUS AND INDUCED
CONSUMPTION (cont.)

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AUTONOMOUS AND INDUCED
CONSUMPTION (cont.)

Consumption function diagram

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AUTONOMOUS AND INDUCED
CONSUMPTION (cont.)

Factors Influencing Consumption All Rights Reserved
 Income level
 Expectation 1–30
 Wealth
 The price level
 Interest rate
 Stock of durable goods

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3. SAVING - AUTONOMOUS AND
INDUCED SAVING (cont.)

Saving Theory
 Autonomous saving or dissaving is the part of savings

not related to income it occurs when there is
autonomous consumption.
 Autonomous consumption is the expenditure incurred
by the consumer if there is no income.
 Saving is considered as part of income received by
households that is not used consumption or
expenditure.

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AUTONOMOUS AND INDUCED
SAVING (cont.)

Concepts of Saving

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AUTONOMOUS AND INDUCED
SAVING (cont.)

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AUTONOMOUS AND INDUCED
SAVING (cont.)

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AUTONOMOUS AND INDUCED
SAVING (cont.)

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AUTONOMOUS AND INDUCED
SAVING (cont.)

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AUTONOMOUS AND INDUCED
SAVING (cont.)

Saving Function
 S = -a + (1 - b)Yd

where,
 -a = autonomous saving
 b = marginal propensity to consume (MPC)
 Thus, (1 - b) = 1 - MPC = MPS

Break-even Income All Rights Reserved

 Break-even point refers to the point at which 1–37
consumption is equal to national income.

 At this point, saving is equal to zero.

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AUTONOMOUS AND INDUCED
SAVING (cont.)

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AUTONOMOUS AND INDUCED
SAVING (cont.)

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AUTONOMOUS AND INDUCED
SAVING (cont.)

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4. ISLAMIC CONSUMPTION THEORY
ACCORDING TO FAHIM KHAN

 According to M. Fahim Khan, a Muslim consumption
pattern is obviously different from the conventional
consumption pattern. This is because Islam has its
own distinct ethical standards, Islamic sociological and
framework.

 Spending in Islam includes consumption as well as
investment, lending and savings in the form of
hoarding.

 Islamic consumption is divided into two types:

(i) Consumption expenditure for self and family (E1)

(ii) Consumption expenditures for others (E2)

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ISLAMIC CONSUMPTION THEORY
ACCORDING TO FAHIM KHAN (cont.)

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ISLAMIC CONSUMPTION THEORY
ACCORDING TO FAHIM KHAN (cont.)

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ISLAMIC CONSUMPTION THEORY
ACCORDING TO FAHIM KHAN (cont.)

Factors Affecting Muslim Consumer’s Behaviour
 The belief in the hereafter life
 The Al-Falah principle
 The principle of wealth
 The principle of consumption of goods and services
 The ethics of consumption

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5. INVESTMENT - AUTONOMOUS
AND INDUCED INVESTMENT

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AUTONOMOUS AND INDUCED
INVESTMENT

1. Autonomous Investment
 Autonomous investment is an investment which is

fixed and does not depend on national income. This
type of investment depends on other factors, such as
interest rate, government spending and the level of
technology.

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AUTONOMOUS AND INDUCED
INVESTMENT (cont.)

2. Induced Investment All Rights Reserved

 Induced investment is the 1–47
investment which depends
on national income. It has
direct relationship between
investment and national
income.

 Induced investment will
increase as national
income increases, since
investors are attracted from
higher national income.

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AUTONOMOUS AND INDUCED
INVESTMENT (cont.)

Factors Influencing Investment All Rights Reserved
 Price and productivity of capital goods
 Expectations of the future 1–48
 Innovations
 Profits
 The rate of interest
 Rate of return
 Government policies

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