ECN 002 (Online Discussion/Quiz (14-01-2022)—National Income and Consumption theories)

1. national income accounting provides information on the trend of economics activity level. Various social and economic phenomena can be explained through the data, which helps the policy makers in farming better economic policies.
2. Product/ value added method
* Income/factor income method
* Expenditure method
3. Relative income theory of consumption
* Life cycle theory of consumption
* Permanent income theory of consumption
* Relative income hypothesis
* The kuznets paradox.
4. A multiplier is simply a factor that amplifies or increase the base value of something else M=1/1(1-MPC).
5. The acceleration principles is an economic concept that draws a connection between fluctuations in consumption and capital investment.

Attah kelechi Rita
2020/242576
kelechirita725@gmail.com.

Business is an occupation or trade and the purchase and sale of products and services to make a profit.
A business concept is the fundamental prerequisites for the existence of a company. It is the form and direction of a company operation .
Basically, there are five important business concept and they are as follows:

1). Customer: customer is the most important part of any business because it put an enterpreneur to the state of asking the question, who are the customer of the product, where does she live? What does she not like about the current product, can she be able to afford the price of the product and services. Understanding the customer means that you can view your business from different angle and that will help boost the business.

2). Supply and Demand: In every market there are two group of people, the buyers(demand) and sellers ( supply). All enterpreneur and business people are supplier by nature. For a supplier to make money and remain in the business he or she must have customer who buys his product. The concept of demand describes a customer’s willingness to pay for a goods and services and that differentiate demand from wishes and want.
3). Competition: Economist refers to this type of concept as monopoly. Most of the world now operates free market economy where anybody who is willing to trade can participate and prices are determined by interaction of demand and supply in the market. Every business continues to look for a way to be attractive to customer and if the do they go into competition with each by providing high quality products and services that are of more value and satisfaction to the consumer .
4). Return on investment: Return on investment is a ratio between net income and investment.
5). Fixed and variable cost : Cost are everything you spend on or pay for to run and keep your business alive.such as rent, equipment, salaries for workers, internet bill etc. Understanding your cost is one of the key element of a successful business. Cost is very important because it is one of the two element that will determine whether you are making profit or loss. They are two main type of cost, fixed cost and variable or marginal cost.
Fixed cost are cost which does not change regardless of quantity of products and services a business produces. Example are: machinery, rent and equipment etc.
Variable cost are cost that change with the level of business activities.

As a student, the business concept I developed to build up my business are making customer and calculating my cost. I achieve this by making Friends and telling them about my business so as to patronize me and calculating my cost at the end of everyday.

NAME: UGWU UKAMAKA MARYTHERES
REG NO: UNN/J21/Socs/010
EMAIL: ugwuukamakamarytheres1@gmail.com

IMPORTANCE OF NATIONAL INCOME ACCOUNTING
• The statistics provided by national income accounting can be used to simplify the procedures and techniques used to measure the aggregate input and output of an economy.
• The data provided is used to frame government economic policies, and it also helps in recognizing the systemic changes happening in the economy.
• National income accounting provides information on the trend of economic activity level. Various social and economic phenomena can be explained through the data, which helps the policymakers in framing better economic policies.
• Central banks can use the national income accounting statistics to vary the rate of interest and set or revise the monetary policy.
• The data on GDP, investments, and expenditures also helps the government to frame or modify policies regarding infrastructure spending and tax rates.
• The national income accounting data also shows the contribution of different sectors, relative to each other, towards economic growth.
The level of economic activity that is taking place in an economy is vitally important because it determines the quantity of goods and services that will be produced in the economy.
This, in turn, gives an indication of the material well-being of the people of a country. Every year, the Indian economy produces a large number (and a wide variety) of goods and services wheat, tomato, banana, apple, cars, shoes, clothing, buildings, houses, medical services, legal services, banking service, electricity, textbooks, etc.
The more of these goods and services that the economy produces, the more we will have available for consumption and the better off we will be.
National income accounts provide information on the pattern of economic activity. These statistics explain various economic and social phenomena. These also help policy-makers in formulating good economic policies both in government and in private industry. This is why national income statistics are closely watched by businesses and governments at all levels.
Just as a business firm comes to know how it is doing by looking at its accounting figures, national income accounting provides us with useful information about how well the economy is performing. E. M. James defines national income accounting as “the whole process of measuring and recording various economic aggregates which give some indication of the economic health of a country over time.”

THREE APPROACHES TO MEASURING NATIONAL INCOME
National income measures the income generated by a country through the production activities that are carried out within a country during a specific period of time.
A circular flow of income and expenditure exists within an economy, where factor income is earned from the production of goods and services, and the income is spent on the purchase of produced goods. Thus, there are three alternative methods of computing national income. This includes:
 Product/Value Added Method
 Income/Factor Income Method
 Expenditure Method
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Product/Value Added Method
The value added method/ product method is also known as the output method or inventory method. In this method, the sum total of the gross value of the final goods and services in different sectors of the economy like industry, service, agriculture, etc. is acquired for the current year by determining the total production that was made during the specific time period. The value obtained is the gross domestic product. Thus, according to this method,
GDP= Total product of (industry + service + agriculture) sector
Symbolically, GDP= ∑ (P × Q)
Where,

P= Market price of goods and services
Q= Total volume of Output
Sometimes goods produced by one sector is further processed by another sector. These goods are termed as intermediate goods and are already included while determining the value of final goods.
So, in order to avoid the problem of double counting of value of goods, the product method if further categorized into two approaches:
The Final Goods Approach
In this method, only the value of final goods and services are computed while estimating GDP, regardless of any intermediate goods and their processing. This method takes into account only those goods and services that purchased and consumed by the final consumers in the economy.
The Value Added Method
In the value added method of measuring national income, the value of materials added by producers at each stage of production to produce the final good is considered. The difference between the value of output and inputs at each stage of production is the value added. Thus,
Value added= Value of output – Cost of intermediate goods
If the differences are added up for all production sectors in the economy, the value of GDP is computed. The table below clearly explains this method:
Producers Stage of Production Selling Price (N) Cost Price (N) Value Added (N)
Farmer Wheat 60 0 60
Miller Flour 90 60 30
Baker Bread 100 90 10
Total 250 150 100
Table 1: Estimation of National Income by Value Added Method
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Income/Factor Income Method
Income method is also termed as factor income method or factor share method. Under this method, national income is measured as the total sum of the factor payments received during a certain time period.
The factors of production include land, labor, capital, and entrepreneurship. Individuals who provide these factor services get payment in the form of rent, wages/salaries, interest, and profit respectively. The total sum of income received by these individuals comprise the national income for a given period of time.
Besides these, there are professionals who employ their own labor and capital like advocates, doctors, barbers, CAs, etc. The income of these individuals are called mixed incomes and are also accounted for calculating the national income. However, income received in the form of transfer payments are not included.
Cite this article as: Palistha Maharjan, “Three Approaches to measuring National Income,” in Businesstopia, January 6, 2018, https://www.businesstopia.net/economics/macro/three-approaches-measuring-national-income.
Thus, according to this method,
GDP= Rent (Rental incomes on agricultural and non-agricultural properties)
+ Wages/Salaries (Wages and salaries earned by employees including supplements)
+ Interest (Net interest earned by individuals other than governmental bodies)
+ Undistributed Profit (Profits earned by businesses before payment of corporate taxes and liabilities)
+ Dividends
+ Direct taxes
+ Depreciation
________________________________________
Expenditure Method
The expenditure method measures the national income as the sum total of expenditures made by individuals on personal consumption, firms on private investments, and government authorities on government purchases.
Since incomes from production are earned as a result of expenditure made by other entities on the produced goods and services within the economy, the result of expenditure method should be same total as the product method. However, with an exception of avoiding intermediate expenditure in order to evade the problem of double counting, national income under expenditure method can be expressed as
GDP= C + I + G + (X – M)
Where, C= Consumption Expenditure (Expenditure on durable goods such as furniture, cars, and non-durable goods such as food)
I= Investment Expenditure (Private investment in capital goods or producer goods such as buildings, machinery, etc.)
G= Government Expenditure (Government expenses for maintaining law and order, developing pre-requisites of development, etc.)
(X-M)= Net Export (Difference between import and export)

3 IMPORTANT THEORIES OF CONSUMPTION
The three most important theories of consumption are as follows:
1. Relative Income Theory of Consumption
2. Life Cycle Theory of Consumption
3. Permanent Income Theory of Consumption.
Introduction:
Keynes mentioned several subjective and objec¬tive factors which determine consumption of a society. However, according to Keynes, of all the factors it is the current level of income that determines the consumption of an individual and also of society.
Since Keynes lays stress on the absolute size of income as a determinant of consumption, his theory of consumption is also known as absolute income theory. Further, Keynes put forward a psychological law of consumption, according to which, as income increases consumption increases but not by as much as the increase in income. In other words, marginal propensity to consume is less than one.
1> ΔC/ΔY >0
Since Keynes propounded his theory of consumption there have been significant developments in this field and several alternative theories of consumer behaviour have been put forward.
First, Duesenberry has propounded that consumption expenditure depends on income of an individual relative to incomes of others rather than the absolute size of his own income.
His theory is therefore called Relative Income Theory of Consumption. Secondly, Modigliani put forward a theory known as life cycle hypothesis, according to which an individual plans his even consumption profile in his lifetime which depends not so much on his current income but on his expectations of income in the whole lifetime.
Further, a famous American economist Friedman has advanced a hypothesis regarding consumption behaviour, called permanent income hypothesis, according to which consumption of an individual depends on permanent income rather than current level of income.
It is important to mention here an important puzzle about consumption function pointed out by Kuznets, a Nobel prize-winner in economics. Contrary to Keynes’s proposition that proportion of income spent on consumption declines as income increases (that is, average propensity to consume falls with the increase in income), Kuznets found from a statistical empirical study of consumption of the economy of the USA that average propensity to consume had remained constant over a long period despite the substantial increase in income.
How the average propensity to consume has remained stable despite the substantial increase in income has been a great puzzle in consumption theory. We shall study below how modern theories of consumption such as Duesenberry’s relative income theory of consumption life cycle hypothesis and Friedman’s permanent income theory suc¬ceed in resolving this puzzle.
1. Relative Income Theory of Consumption:
An American economist J.S. Duesenberry put forward the theory of consumer behaviour which lays stress on relative income of an individual rather than his absolute income as a determinant of his consumption. Another important departure made by Duesenberry from Keynes’s consumption theory is that, according to him, the consumption of a person does not depend on his current income but on certain previously reached income level.
According to Duesenberry’s relative income hypothesis, consumption of an individual is not the function of his absolute income but of his relative position in the income distribution in a society, that is, his consumption depends on his income relative to the incomes of other individuals in the society. For example, if the incomes of all individuals in a society increase by the same percent¬age, then his relative income would remain the same, though his absolute income would have in¬creased.
According to Duesenberry, because his relative income has remained the same the individual will spend the same proportion of his income on consumption as he was doing before the absolute increase in his income. That is, his average propensity to consume (APC) will remain the same despite the increase in his absolute income.
As mentioned above, empirical studies based on time-series data made by Kuznets reveal that over a long period the average propensity to consume remains almost constant. Now, Duesenberry’s relative income hypothesis suggests that in the long run the community would continue to consume the same proportion of income as its income increases.
According to Duesenberry, saving as a proportion of income of the individuals with relatively low incomes would not rise much with the increase in their incomes. That is, their savings would not rise to the same proportion of income as was being done by the individuals who had the same higher income prior to the present increase in income.
This is because with the increase in incomes of all individuals by the same proportion, the relative incomes of the individuals would not change and therefore they would consume the same proportion of their income. This applies to all individuals and households. It therefore follows that assuming that relative distribution of income remains the same with the growth of income of a society, its average propensity to consume (APC) would remain constant.
Thus, this conclusion of the relative income hypothesis differs from the Keynesian theory of consumption according to which, as seen above, as absolute income of a community increases, it will devote a smaller proportion of its income to con-sumption expenditure, that is, its APC will decline.
It is important to note that relative in¬come theory implies that with the increase in income of a community, the relative distribu¬tion of income remaining the same, does not move along the same aggregate consump¬tion function, but its consumption function shifts upward. Since as income increases, movement along the same consumption function curve implies a fall in average pro¬pensity to consume, Duesenberry’s relative income hypothesis suggests that as income increases consumption function curve shifts above so that average propensity to con¬sume remains constant.
As income increases and a society moves along the same consumption function curve, its average propensity to consume falls. But Duesenberry’s relative income hypothesis suggests that as income increases consumption function curver shifts above so that average propensity to consume remains constant.
Demonstration Effect:
By emphasising relative income as a determinant of consumption, the relative income hypothesis suggests that individuals or households try to imitate or copy the con¬sumption levels of their neighbours or other families in a particular community. This is called demon¬stration effect or Duesenberry effect. Two things follows from this. First, the average propensity to consume does not fall.
This is because if incomes of all families increase in the same proportion, distribution of relative incomes would remain unchanged and therefore the proportion of consump¬tion expenditure to income which depends on relative income will remain constant.
Secondly, a family with a given income would devote more of his income to consumption if it is living in a community in which that income is regarded as relatively low because of the working of demonstration effect. On the other hand, a family will spend a lower proportion of its income if it is living in a community in which that income is considered as relatively high because demonstration effect will not be present in this case.
For example, the recent studies of household expenditure made in India reveal that the families with a given income, say N5000 per month spend a larger propor¬tion of their income on consumption if they live in urban areas as compared to their counterparts in rural areas.
The higher propensity to consume of families living in urban areas is due to the working of demonstration effect where families with relatively higher income reside whose higher consump¬tion standards tempt others in lower income brackets to consume more.
Ratchet Effect:
The other significant part of Duesenberry’s relative income hypothesis is that it suggests that when income of individuals or households falls, their consumption expenditure does not fall much. This is often called a ratchet effect. This is because, according to Duesenberry, the people try to maintain their consumption at the highest level attained earlier. This is partly due to the demon¬stration effect explained above. People do not want to show to their neighbours that they no longer afford to maintain their high standard of living.
Further, this is also partly due to the fact that they become accustomed to their previous higher level of consumption and it is quite hard and difficult to reduce their consumption expenditure when their income has fallen. They maintain their earlier con¬sumption level by reducing their savings. Therefore, the fall in their income, as during the period of recession or depression, does not result in decrease in consumption expenditure very much as one would conclude from family budget studies.
Aggregate consumption function of the community:
From the analysis of dem¬onstration and ratchet effects it follows that Duesenberry’s relative income hypothesis provides an explanation for why aggregate consumption function of the community may be flatter than the family budget studies would suggest. Duesenberry emphasizes that it is relative income rather than absolute income which determines consumption expenditure of households.
When income of the community increases, relative income remaining constant, the proportion of consumption expenditure to income will not increase much because relative incomes of the households remain the same (Note that this implies that saving ratio will not rise much).
Due to demonstration effect every household will increase its expenditure in the same proportion as the increase in income. On the other hand, if the income of the community decreases, the consumption expenditure would not decline much due to the ratchet effect according to which people try to maintain their previously attained higher level of consumption. This makes the consumption function of the community flatter than suggested by the cross-sectional family budget studies.
Further, it also follows from the Duesenberry relative income hypothesis that short-run aggre¬gate consumption function of the community is linear rather than curved. As stated above, if, in the short run, the level of income increases, the proportion of consumption expenditure to income is not likely to increase much due to the operation of demonstration effect and with the fall in income the proportion of consumption to income is not likely to decline much due to the ratchet effect.
This makes the short-run aggregate consumption function of the community linear. It is worth noting that Duesenberry’s theory assumes that relative distribution of income does not change much. This is in accord with the facts of the real world situation where changes in income distribution do not take place in the short run. Thus Duesenberry’s theory provides a convincing explanation in terms of demonstration and ratchet effects why aggregate consumption function is linear rather than non¬linear.

2. Life Cycle Theory of Consumption:
An important post-Keynesian theory of consumption has been put forward by Modigliani and Ando which is known as life cycle theory. According to life cycle theory, the consumption in any period is not the function of current income of that period but of the whole lifetime expected income.
Thus, in life cycle hypothesis the individual is assumed to plan a pattern of consumption expenditure based on expected income in their entire lifetime. It is further assumed that individual maintains a more or less constant or slightly increasing level of consumption.
However, this level of consumption is limited by his expectations of lifetime income. A typical individual in this theory in his early years of life spends on consumption either by borrowing from others or spending the assets bequeathed from his parents.
It is in his main working years of his lifetime that he consumes less than the income he earns and therefore makes net positive savings. He invests these savings in assets, that is, accumu¬lates wealth which he consumes in the future years. In his lifetime after retirement he again dis-saves, that is, consumes more than his income in these later years of his life but is able to maintain or even slightly increase his con¬sumption in the lifetime after retirement.

Some important conclusions follow from the life cycle theory of consumption. The fundamental idea of the life-cycle hypothesis is that people make their consumption plans for their entire lifetime and further that they make their lifetime consumption plans on the basis of their expectations of lifetime income. Thus in the life cycle model consumption is not a mere function of current income but on the expected lifetime income. Besides, in life cycle theory the wealth presently held by individu¬als also affects their consumption.
How the consumption of an individual in a period depends on these factors highlighted by life cycle theory can be expressed in the form of an equation. To do so let us consider an individual of a given age with an additional life expectancy of T years and intends to retire from working after serving for N years more. Then suppose that in the current period and thereafter in his life span the individual will consume a constant proportion, 1/T of his life-time income in equal installments per year.
Thus
Ct= 1/ T (YLt+(N-1)YeL+Wt)
where
Ct = the consumption expenditure in the current period t
YLt = Income earned from doing some labour in the current period t
N-1 = remaining future years of doing some labour or work
YeL – the average annual income expected to be earned over N-1 years for which indi¬vidual plans to do some work
Wt = the presently held wealth or assets
It will be observed from the above equation that life cycle hypothesis suggests that consumption in any period does not depend only on current income but also on expected income over his entire working years. Besides, consumption in any period also depends on his presently owned wealth or assets which are built up during the prime working years of one’s life when income exceeds savings.
The general consumption behaviour as suggested by Ando-Modigliani life cycle hypothesis can be expressed in the following functional form:
Ct= b1YLt+b2YeL+b3Wt
where
Ct = Consumption expenditure in a period t.
YLt = Income earned from doing some labour in the current period t.
YeL = the average annual income expected to be earned from labour during the further years of working life.
Wt – wealth currently owned
b1 represents marginal propensity to consume out of current income
b2 is marginal propensity to consume out of expected lifetime income, and
b3 is the marginal propensity to consume out of wealth.
It is significant to note that consumption would not be much responsive to changes in current income (i.e., YLt) unless it also changes expected future lifetime income (YeL). A one time or temporary change in income, say, by N. 1000, will affect consumption in the same way as the increase in wealth.
The consumption of these N 1000 will be spread over the entire lifetime in a planned consumption flow per period. With 50 years of future life, increase of N 1000 of transient or temporary income will raise the consumption by 1000/50 =N20 per period. This implies that consumption function curve will shift above.
A permanent increase in income that is expected to persist throughout the working years, which implies that in future expected lifetime income also rises, will produce a large effect on consumption in each of the remaining period of one’s lifetime. Further, the increase in wealth will shift the consumption function upward, that is, will increase the intercept term of the consumption function.
To estimate behaviour of the consumer on the basis of life cycle hypothesis, one is required to make some assumptions how people form their expectations regarding labour income over their life time. In the study of consumption function for the United States, Ando and Modigliani made the assumption that the expected future labour income is simply a multiple of current labour income. Thus, according to this assumption,
YeL = βYLT
where β is a multiple of current labour income. This assumption implies that people revise their expected labour income of future by a certain multiple of the change in current labour income. With this assumption, aggregate consumption function for the community can be expressed as under
C1 = (b1 +b2β)YLT +b3Wt
This function has been estimated taking time-series data for the U.S.A. and the following esti¬mates have been obtained :
Ct = 0.72 YLT+0.06W
According to these estimates, if current labour income increases by N100 along with assumed effect on expected future income, consumption will increase by N72 per period. Besides, the in¬crease in wealth by N100 will raise the consumption expenditure by N6. It therefore follows that according to life cycle hypothesis the relationship between income and consumption is non-proportional, increase in labour income by N100 crore leads to increase in consumption by N72. Further, the increase in wealth will shift the consumption function upward, that is, will increase the inter¬cept term of the consumption function.
Since the ratios of wealth and labour income are constant over time, the life cycle consumption function is in accord with the conclusion arrived at by Kuznets from the long-run time series data that the long-run consumption function is proportional, with average propensity to consume (APC or MPC) remaining constant and being equal to nearly 0.9. These facts are quite consistent with the long-run consumption function of life cycle hypothesis and thus help in resolving the Kuznets puzzle.
Life cycle hypothesis also explains the non-proportional relationship between consumption and income found in the cross-sectional family budget-studies. It has been found in these studies that high income families consume a smaller proportion of their income, that is, their average propensity to consume (APC) is relatively lower than those of the low-income families. This can be easily ex-plained by life-cycle hypothesis. Suppose we choose a random sample of families from the popula¬tion and rank them according to their incomes.
The families with higher incomes are expected to be middle-aged income earners who are in the prime working years of their lifetime and therefore earn more than they consume (i.e., their APC will be relatively lower). On the other hand, the families with lower incomes are likely to have relatively high proportion of new entrants into the labour force and the old people who have retired and, as seen above, they consume more than their current income and their APC being quite high pushes up the APC of the low income families.
Shortcomings:
Although life cycle theory has provided an explanation of various puzzles about consumption function, it is not without critics, Gardner Ackley has criticized the assumption of life cycle hypothesis that in making consumption plans, households have “a definite and conscious vision.”
According to Ackley, the possession of this vision on the part of households sounds unrealistic. Further, according to him, to assume that a household has complete knowledge of “family’s future size, including the life expectancy of each member, entire lifetime profile of income of each member, the extent of credit available in the future, future emergencies, opportunities and social pressure which have a bearing on consumption spending” is quite unrealistic.
Life cycle theory has also been criticized that it fails to recognize the importance of liquidity constraints in determining the response of consumption to income. According to critics, even if a household has a concrete vision of future income, the opportunities to borrow from the capital mar¬kets for quite a long period on the basis of expected future income, as has been visualised by life cycle hypothesis, are very little. This creates the liquidity constraints for deciding about consumption plans. As a result, the consumption becomes highly responsive to current income which is quite contrary to the life cycle hypothesis.

3. Permanent Income Theory of Consumption:
Permanent income theory of consumers’ behaviour has been put forward by a well-known American economist, Milton Friedman. Though Friedman’s permanent income hypothesis differs from life cycle consumption theory in details, it has important common features with the latter. Like the life cycle approach, according to Friedman, consumption is determined by long-term expected income rather than current level of income.
It is this long-term expected income which is called by Friedman as permanent income on the basis of which people make their consumption plans. To make his point clear, Friedman gives an example which is worth quoting. According to Friedman, an individual who is paid or receives income only once a week, say on Friday, he would not concentrate his consumption on one day with zero consumption on all other days of the week.
He argues that an individual would prefer a smooth consumption flow per day rather than plenty of consumption today and little con¬sumption tomorrow. Thus consumption in one day is not determined by income received on that particular day. Instead, it is determined by average daily income received for a period. This is on the line of life cycle hypothesis. Thus, according to him, people plan their consumption on the basis of expected average income over a long period which Friedman calls permanent income.
It may be noted that permanent income or expected long-term average income is earned from both “human and non-human wealth”. The income earned from human wealth which is also called human capital refers to the return on income derived from selling household’s labour services, that is, efforts and abilities of its labour.
This is generally referred to as labour income. Non-human wealth consists of tangible assets such as saved money, debentures, equity shares, real estate and consumer durables. It is worth noting that Friedman regards consumer durables such as cars, refrigerators, air conditioners, television sets as part of households’ non-human wealth. The imputed value of the flow of services from these consumer durables is considered as consumption by Friedman.
Relationship between Consumption and Permanent Income:
Now, what is the precise relationship between consumption and permanent income (that is, the expected long period average income). According to permanent income hypothesis, Friedman thinks that consumption is proportional to permanent income
CP=kYP
where
YP is the permanent income
CP is the permanent consumption
k is the proportion of permanent income that is consumed.
The proportion or fraction k of permanent income that is consumed depends upon the following factors:
1. Rate of interest (i):
At a higher rate of interest the people would tend to save more and their consumption expenditure will decrease. The lowering of rate of interest will have opposite effect on the consumption.
2. The proportion of non-human wealth to human wealth:
The relative amounts of income from physical assets (i.e., non-human wealth) and income from labour (i.e., human wealth) also affects consumption expenditure. This is denoted by the term w in the permanent consumption func-tion and is measured by the ratio of non-human wealth to income. In his permanent income hypoth¬esis Friedman suggests that consumption expenditure depends a good deal on the wealth or assets possessed by the people. The greater the amount of wealth or assets held by an individual, the greater would be its propensity to consume and vice-versa.
3. Desire to add to one’s wealth:
Lastly, households’ preference for immediate consumption as against the desire to add to the stock of wealth or assets also determines the proportion of permanent income to be devoted to consumption. The desire to add to one’s wealth rather than to fulfill one’s wants of immediate consumption is denoted by u.
Thus rewriting the consumption function based on Friedman’s permanent income hypothesis we have
CP =k (i, w, u) YP
The above function implies that permanent consumption is function of permanent income. The proportion of permanent income devoted to consumption depends on the rate of interest (i), the ratio of non-human wealth to labour income (w) and desire to add to the stock of assets (u).
Permanent and transitory income:
In addition to permanent income, the individual’s income may contain a transitory component that Friedman calls as a transitory income. A transitory income is a temporary income that is not going to persist in future periods. For example, a clerk in an office may get a substantial income from overtime work in a month which he thinks cannot be maintained.
Thus, this large overtime income for a month will be transitory component of income. According to Fried¬man, transitory income is not likely to have much effect on consumption.
Thus, income of an indi¬vidual consists of two parts, permanent and transitory, which we may write as under:
YM = Yp + Yt
where YM is measured income in a period, Yp is the permanent income and Yt is transitory income.
Measuring permanent income:
To make the permanent income hypothesis operational we need to measure permanent income. Permanent income, as is generally defined is “the steady rate of consump¬tion a person could maintain for the rest of his or her life, given the present level of wealth and income now and in the future.”
However, it is very difficult for a person to know what part of any change in income is likely to persist and is therefore permanent and what part would not persist and is therefore transitory. Friedman has suggested a simple way of measuring permanent income by relating it to the current and past incomes. According to him, permanent income is equal to the last year’s income plus a proportion of change in income occurred between the last year and the current year.
Thus, permanent income can be measured as under:
YP= Yt-1 + a(Yt – Yt-1) 0 < a Y t-1 the equation shows that there is positive net investment during the period t—if Yt < Yt–1, there is negative net investment, or disinvestment during period t. If, however, we want to show gross rather than net investment, all that is needed is to add replacement investment to both sides of the equation. This replacement investment is taken to be equal to depreciation and is shown by Dt, we have thus:
It + Dt = w(Yt – Y t-1) + Dt
But as has been shown in case V in the above table the negative net investment in plant and equipment is limited to the amount of depreciation of the capital stock, the sum of It and Dt cannot be less than zero. If Igt represents gross investment in period t. we have:
Igt = w(Yt – Y t-1) + Dt …(iii)
Investment will respond to changes in the level of output shown by the equation only if certain assumptions are satisfied, the most important being the absence of excess capacity, if X, shows the excess capacity at the beginning of the period t, we may rewrite equation (iii) as:
Igt = w (Yt – Yt-1) + Dt – Xt
Whatever the level of gross investment might otherwise be in period t, it will be reduced by the amount of Xt. If the value of w(Yt – Y t-1)+Dt, happened to be equal to or less than Xt—then Igt, would be zero—the minimum possible for gross investment in plant and equipment as elaborated by case V in the table already given.
The sets of equations just developed in support of the illustrative cases I to V in the table already given are significant, at least for two reasons:
Firstly, they indicate the causal relationship between changes in output and investment spending.
Secondly, they point out to the fact that the investment spending resulting from a change in output is likely to be larger than the changes in output that caused it.

1) a) National income accounting enables us to know the relative importance of the various sectors of the economic

b)It helps in measuring inflation and deflation changes.

c)It shows how national expenditure is divided between consumption expenditure and investment expenditure

2) a) Expenditure method
b) Factor income method
c) Output (Value added method)

3)a) Absolute income theory:This is a theory propounded by an English economist (John myenant keynes in 1936. This theory identified the relationship between income and consumption as a key macro economic relationship.Keynes wrote that “The fundamental psychological law,upon which we are entitled to depend with great confidence……is that men are disposed,as a rule and on the average to increase their consumption as their income increase,but not by as much as the increase in their income”. when applied to a cross section of a population.Rich people are expected to consume a lower proportion of their income than poor people.

b) Permanent income theory;This theory was propounded by milton freed man ,It states that individual consumption depends on their permanent income rather than their current level of income.They argued that people’s consumption is not only the function of their current income but also of their expected income, Thus it’s considered income and consumption In 2 component namely
1) Permanent income and Permanent consumption
2) Transitory Income and Transitory Consumption
Transitory Income is an unexpected income that consumer gets,it comes anytime, it’s never expected

C) Lifecycle theory;
This theory was argued by individuals,they argued that individuals planned their consumption for their whole life time.Thus consumption doesn’t depend on current level of income but on expectation on whole life time income, people consume base on their consumption on a constant percentage on their anticipated life income

d) Relative income theory:This theory was propounded by James duesenberry,It states that the satisfaction an individual derives from a given consumption level depends on its relative magnitude in the society, Relative income measures your income in relation to other members of the society.

4) Multiplier ; This explains what happened to the national income if there is a change in any of the component of aggregate demand
The multiplier shows how a given increase or decrease in spending leads to a greater increase or decrease in income

5) Accelerator principle;
This is an economic concept that draws a connection between fluctuations in consumption and capital investment.It States when demand for consumer increases, demand for equipment and other investment necessary to make these goods will grow even more.

1- important of national income accounting 1. It helps to know the inflation rate and the deflation rate 2. It helps to know the type of commodity topping the charts 3. It also help to know the type of budget to use in a country 4. It helps money going out of the country 5. It help to know what to produce in a country as a whole 6. It help to know the county gaining in an economy chart.2- three approaches in national income accounting 1. The expenditure method : this explains the expenses the country has which is been calculated .2. The factor income method : this is we’re the payment of salaries for the labourers are carried out. 3- The value added tax :this is were all the resources used in the firm are been calculated. 3- absolute income hypothesis: this is the relationship between the income and the consumption that is we humans our income is based on different types , the poor spend more on consumption when received income,will the rich spends less. 2- permanent income hypothesis: is explained that most of our consumption is based on our legally made income rather than the transitory income which is the unexpected income.3- life cycle hypothesis : consumption is based on biological factors that is to say that we young employers/labourers have to spend ,and the older ones which have retired save for future expectations. Relative income hypothesis: this is based on the money we have received which was used for consumption. Multipliers: this shows the increasing or decreasing income and the increase or decrease in consumption. Accelerator :is the demand of goods , which can also great more investment to the firm to bring about more income.

1.national income accounting is a bookkeeping system that a given uses to measure the level of the country’s economic activity in a given time period.Accounting record’s of this nature include data regarding total revenues earned by domestic corporations,wages paid to foreign and domestic worker’s,and the amount spent on sales and income taxes by corporations and individuals residing in the country.
-national Inc accounting is a government bookkeeping system that measures a country’s economic activity offering insight into how an economy is performing.
-such a system will include total revenues by dom corporations, wages paid and sales and income tax data for companies.
Importance of national income accounting.
A.setting economic policy. National income indicates the status of the economy and can give a clear picture of the countries economic growth.
B.inflation and deflationary gaps:for timely anti-inflationary and deflationary policies, we need aggregate data of national income.if expenditure increases from the total output,it shows inflammatory gaps and vice versa.
C.Budget preparation: Budget of the country is highly dependent on the net national income and its concepts.The government formulates the yearly budget with the help of national income statistics in order to avoid any cynical policies.
D.Standard of living: National income data assists the government in comparing the standard of living amongst countries and people living in the same country at different time.
E.Defence and development: National income estimates help us to bifurcate the national product between defence and development purposes of the country. From such figures,we can easily know, how much can be set aside of the defence budget.
2ai). Product method: In this method, national income is measured as a flow of goods and services.we calculate money value of all final goods and services produced in an economy during a year. Final goods here refer to those goods which are directly consumed and not used in further production process. Goods which are further used in production process are called intermediate goods.
bii) Income method: Under this method, national income is measured as a flow of factor incomes.There are generally four factors of production labour, capital, land and entrepreneurship. Labour gets wages and salaries, capital gets interest, land gets rent and entrepreneurship gets profit as their remuneration. Besides, there are some self-employed persons who employ their own labour and capital such as doctors, advocates, CAS, etc.
Their income is called mixed Income. The sum-total of all these factor income is called NDP at factor costs.
-Expenditure method: In this method, national income is measured as a flow of expenditure. GDP is sum-total of private consumption expenditure. Government consumption expenditure,gross capital formation (Government and private) and net exports (export – import).
3a. The absolute income hypothesis: The consumption function, a key behavioral relationship in macroeconomics, was first introduced by John Maynarel Keynes (1883-1946). In 1936.it is an economic term that simply describes the amount of money that an individual is compensated for his or her work.call it wages,salary, earnings,or take-home pay, it’s all income. Broadly speaking, consumption is understood to increase as income rises and to decrease as income falls.
3b. Relative income hypothesis: Relative income hypothesis states that the satisfaction (or-utility) an individual derives from a given consumption level depends on its relative magnitude in the society ( eg, relative to the average consumption)
Rather than it’s absolute level.it is based on a postulate that has long been acknowledged by psychologists and sociologists, namely that individuals care about status. In economics, relative income hypothesis is attributed to James duesenberry, who investigated the implications of this idea for consumption behavior in his 1949 book titled income,saving and the theory of consumer behavior.
3c. The permanent income hypothesis:is a theory of consumer spending stating that people will spend money at a level consistent with their expected long-term average income. The level of expected long-term income then become thought of as the level of permanent income that can be safely spent. A worker will save only I their current income is higher than the anticipated level of permanent income, in order to guard against future declines in income .The permanent income hypothesis was formulated by the Nobel prize- winning economist Milton Friedman in 1957. The hypothesis implies that changes in consumption behavior are not predictable because they are based on individual expectations. This has broad implications concerning economic policy.
3d. The life-cycle hypothesis: this was developed by Franco Modigliani in 1957. The theory States that individuals seek to smooth consumption over the course of a lifetime, borrowing in times of low-income and saving during periods of high income.
4. In economics, a multiplier broadly refers to an economic factor that when increased or changed, causes increases or changes in many other related economic variables. In terms of gross domestic product, the multiplier effect causes gains in total output to be greater than the change in spending that caused it. The term multiplier is usually used in reference to the relationship between government spending and total national income multipliers are also used in explaining fractional reserve banking,known as the deposit multiplier. A multiplier refers to an economic factors that, when applied, amplifies the effect of some other outcome. A multiplier value of 2x would triple it.many examples of multipliers exist,such as the use of margin in trading or the money multiplier in fractional reserve banking. Calculating the multiplier. The formula to determine the multiplier is M=1/(1-MPC).
5).The acceleration principle is an economic concept that draws a connection between fluctuations in consumption and capital investment. It states that when demand for consumer goods increases, demand for equipment and other investments necessary to make these goods will grow even more. In other words, if a population’s income increases and it, as a result, begins to consume more, there will be a corresponding but magnified change in investment.Under the acceleration principle, the reverse is also true, meaning a decrease in consumption spending will tend to be matched by a larger relative decrease in investment spending as businesses freeze investment in the face of falling demand. The acceleration principle, also referred to as the accelerator principle or the accelerator effect, thus helps to explain how business cycles can propagate from the consumer sector into the business sector.

1. National income accounting provides information on the trend of economic activity level. Various social and economic phenomena can be explained through the data, which helps the policymakers in framing better economic policies.

2i. Product method: Also known as the value-added method, the product method is based on the net value added to the product at every stage of production. In the product method, the economy is usually divided into different industry sectors, such as fishing, agriculture, and transport.
2ii. Income method: In the income method, the national income is measured by adding up the pretax income generated by the individuals and companies in the economy. It consists of income from wages, rent of buildings and land, interest on capital, profits, etc. in an accounting year. The income method shows the national income distribution among different earning groups in the economy.
2iii. Expenditure method: In the expenditure method, the national income is measured by adding up the expenditures made by individuals, companies, and the government. Thus, it combines consumer spending, investments made by companies, net exports, and government spending to calculate the national income.

3i. The Absolute Income Hypothesis: The basic tenet of the absolute income theory is that the individual consumer determines what fraction of his current income he will devote to consumption on the basis of the absolute level of that income. Other things being equal, a rise in his absolute income will lead to a decrease in the fraction of that Income devoted to consumption.
3ii. Relative Income Hypothesis: the relative income theory argues that the fraction of a family’s income spent on consumption depends on the level of its income relative to the income of neighbouring family’s and not on the absolute level of the family’s income. If a family’s income increases but its relative position on the income scale remains unchanged because incomes of other families have also risen at the same rate, its division of income between C and S will remain unchanged. According to the relative income theory, each family, in deciding on the fraction of its income to be spent, is uninfluenced by the fact that it is twice as well off in absolute terms and is influenced only by the fact that it is no better off at all in relative terms
3iii. The Permanent Income Hypothesis: It is a theory that attempts to explain away apparent inconsistencies of empirical data on the relationship of saving to income. Data for a single year show that, as income rises, savings account for an increasing share of income, while data for a long period of years show that, even though total income rises over the years, total savings account for a fairly stable share of total income. Milton Friedman states that this does not occur because of changes in consumption habits at every income level but because a study of measured income and consumption involves inaccurate concepts of what these habits really are.
3iv. Life Cycle Hypothesis: life cycle hypothesis serves at least to remind us that savings and consumption pattern and involve more than blind psychological urges for thrift or unthinking and mechanical responses to changes in the level of current income. The life cycle consumption function that we have derived, differs from its simple Keynesian counterpart because in the life cycle consumption function, consumption is taken as a function of wealth and of age and not simple of current income.

4. The multiplier broadly refers to an economic factor that, when increased or changed, causes increases or changes in many other related economic variables. In terms of gross domestic product, the multiplier effect causes gains in total output to be greater than the change in spending that caused it.

5. The acceleration principle is an economic concept that draws a connection between fluctuations in consumption and capital investment. It states that when demand for consumer goods increases, demand for equipment and other investments necessary to make these goods will grow even more. In other words, if a population’s income increases and it, as a result, begins to consume more, there will be a corresponding but magnified change in investment.

1: GDP helps to estimate the size and the economy growth rate of a country
2: it helps in economic planning
3: it helps to compare how different economies are performing across countries
4: National income accounting helps to guide aganst reception because when national income accounting is to help to know if the economy is growing or not

B 1:available added
2:income method
3:expenditure method

C:1absolute income hypothes( this theory identify the relationship between income and consumption as a key
2: permanent income hypothesis
3: life cycle hypothesis
4: relative income hypothesis

D) the multiplier
Explains what happens to d national income change day in day of the compunet in any of the average demand eg the total expenditure increase by 50m of a level of income by how much will the equilibrium income change.

E) 1: the acceleration principle is an economic concept that draws a connection between fluctuations in consumption and capital investment. It states that when demand for consumer goods increases, demand for equipment and other investment necessary to make these goods will grow even more

1. National income accounting provides information on the pattern of economic activity.These statistic explains various economic and social phenomena

2.Product method
Income method
Expenditure method

3. Absolute income hypothesis:This theory identifies the relationship btw income and consumption as a key micro economy relationship.keynes quoted that “men are disposed as a rule and on the average to increase their comsumption as their income increases, but not by as much as the increase with their income

Permanent income hypothesis:it simply states that individual consumption depends on their permanent income rather than than their current levels of income

Life cycle hypothesis: it persume that individuals base their consumption on a constant percentage of their anticipated life income eg people save for retirement while they earn a regular income rather than spending it all when it is earned

Relative income hypothesis:this states that people spend relative to thieir society where by poor people spend more than the rich people.

4.The multiplier explains what happens to the national income if there is a change in any component of aggregate demand . For example suppose variable x changes by 1 unit, which causes another variable y to change by M units.Then the multiplier is M. Multiplier in essence shows how a giving increase or decrease in spending leads to a greater increase or decrease in income.

5. The acceleration principle is an economic concept that draws a connection between fluctuation in consumption and capital investment . It states that when a consumer goods increases,demand for equipment and other investments neccessary to make these goods grow even more

1) importance of national income accounting

I) The statistics provided by national income accounting can be used to simplify the procedures and techniques used to measure the aggregate input and output of an economy.
II)The data provided is used to frame government economic policies and it also helps in recognizing the systematic changes happening in the economy.
III)It provides information on the trend of economic activity level, various social and economic phenomena can be explained through the data.
IV) Central banks can use the national income accounting statistics to vary the rate of interest and set it revise the monetary policy.
V)The data on GDP, investment and expenditures also helps the government to frame or modify policies regarding infrastructure spending and tax rates.
VI)The national income accounting data also shows the contribution of different sectors, relative to each other towards economic growth.

2) Three approaches to national income accounting

I)The product approach: This is method used by salespeople to approach prospects in which they demonstrate the product features and benefits as they walk up to the prospects.

II)The income approach: This is a type of real estate appraisal method that allows investors to estimated the value of a property based on the income the property generates.

III)The expenditure approach: This is a method for calculating a nation’s gross domestic product (GDP). By considering the private sector, investors, and government spending as well as net exports.

3)Theories of consumptions(at least four of five theories)

I)The Absolute Income Hypothesis:(AIH) This is the part of theory of consumption propounded by economist John Maynard Keynes.the Hypothesis was refined extensively during the 1960s and 1979s, notably by American economist James Tobin (1918-2002).It concerns how a consumer divides his disposable income between consumption and savings.when applied to a cross section of the population, rich people are expected to consume a lower proportion of their income than poor people.

II) Relative Income Hypothesis: Developed by James Duesenberry, the relative income hypothesis (RIH) states that an individual attributes to consumption and savings is dictated more by his income relation to others,than by abstract standard of living; the percentage of income consumed by an individual depends on his percentile position within the income distribution. It hypothesizes that the present consumption is not influenced merely by present levels of absolute and relative income, but also by levels of consumption attained in a previous period.

III) The permanent Income Hypothesis: (PIH) This is a theory of consumer spending stating that people will spend money at a level consistent with their expected long-term average income. The level of expected long-term income then becomes thought of as the level of “permanent” income that can be safely spent. A worker will save only if their current income is higher than the anticipated level of permanent income, in order to gaurd against future declines in income. Milton Friedman developed the permanent income hypothesis, believing that consumer spending is a result of estimated future income as opposed to consumption that is based on current after-tax income.

IV) Life Cycle Hypothesis:(LCH) Is an economic theory that describes the spending and saving habits of people over the course of a lifetime. The theory states that individuals seek to smooth consumption throughout their lifetime by borrowing when their income is low and saving when their income is high. The concept was developed by economist Franco Modigliani and his student Richard Brumberg in the early 1950s. One implication is that younger people have a greater capacity to take investment risks than older individuals who need to draw down accumulated savings. The LCH assumes that individuals plan their spending over their lifetimes, taking into account their future income. Accordingly, they take on debt when they are young, assuming future income will enable them to pay it off. they then save during middle age in order to maintain their level of consumption when they retire.

4) The Multiplier: This is an economic theory that asserts an increase in private consumption, expenditure, investment expenditure, or net government spending (gross government spending minus government tax revenue) raises the total Gross Domestic Product (GDP) by more than the amount of the increase. If private consumption expenditure increases by 10 units, the total GDP will increase by move than 10 units. The multiplier also shows how a given increase it decrease in spending leads to a greater increase or decrease income.

5) The Accelerator Principle: This is an economic concept that draws a connection between fluctuations in consumption and capital investment. It states that when demand for consumer goods increases, demand for equipment and other investment necessary to make these goods will grow even more. In other words, if a population’s income increases and as a result, begins to consume more, there will be a corresponding but magnified change in investment. It does not compute the rate of capital investment as a product of the overall level of consumption, but as a product of the rate of change in the level of consumption. Under the acceleration principle, the reverse is also true, meaning a decrease in consumption spending will tend to be matched by a larger relative, decrease in investment spending as business freeze. Investment in the face of falling demand , the acceleration principle, also referred to as the accelerator Principle or the accelerator effects, thus helps to explain how business cycles can propagate from the consumer sector into the business sector.

1. Indicator of economic structure
Provision of depreciation
Important to defense and development
Indicator of economics welfare and international comparism
Helpful to formulate economic policy and planning.

2. Product method
Income method
Expenditure method

3. The absolute income hypothesis
Relative income hypothesis
The permanent income hypothesis
Life cycle hypothesis

4. The multiplier effect refers to the effect on national income and product of an exogenous increase in demand. Consequently, consumption demand increases and firms and firms then produce to meet this demand. Thus, the national income and product rises by more than the increase in investment.

1.it measures the economy performance by measuring the flow of income and expenditure over a period of time
1b.Calculate the rate of growth of output in the economy
2.The product (output) method:it emphasize on the output figure of all firms in economy to get the total value of the nation output/final goods
2b.The income method: These approach is to measure income generated by production
2c.Expenditure method: These method is used to measure the total value of goods and services produced within a nation borders at the current market value
3.Relative Income: These hypothesis states that saving rate depends on the relative position of the individual on the income scale.
3b.The absolute income hypothesis: This theory state that “men are dispose as a rule on average,to increase their consumption as the income increase, but not by as much as the income.
3c. The permanent hypothesis: it’s a theory that attempt to explain away apparent inconsistencies of empirical data on the relationship of saving to income
3d.Life cycle hypothesis: The theory state that consumer unit is assumed to determine its standard of living on the basis of expected returns from it’s resource over its life time
4. The multiplier : it’s an economic term, referring bro the proportional amount of increase or decrease in the final income that results from an injection, withdrawal of capital
5.The Accelerator Principle: it’s an economic term that draw a connection between fluctuations in consumption and capital investment.

1a. National income accounting provides information on the trend of economic activity level.
b. It allows us to make comparisons with other nations.
c. It helps us to understand individual sector of the economy and their growth.
d. Since the economy is so large and made up of many different parts, national income accounting allows economists to break up the many parts and determine how well they are functioning and growing
2a. Product method.
b. Income method.
c. Expenditure method.
a. Product method: In this method, national income is measured as a flow of goods and services. We calculates money of all final goods and services produced in an economy during a year. Final goods here refer to those goods which are directly consumed and not used in further production process. Goods which are further used in production process are called intermediate goods. In the value of final goods, value of intermediate goods is already included therefore we do not count value of intermediate goods in national income otherwise there will be double counting of values of goods.
To avoid the problem if double counting, we can use the value-addition method in which not the whole value of a commodity but value addition at each stage of production is calculated and these are summed up to arrive at GDP.
b. Income method: In this method, national income is measured as a flow of factor incomes. There are generally four factors of production; labour, capital, land and entrepreneurship. Labour gets wages and salaries, capital gets interest, land gets rent and entrepreneurship gets profit as there remuneration.
Besides, there are some self employed person who employ their own labour and capital such as doctors, advocates, etc. Their income is called mixed income. The sum-total of all these factor incomes is called NDP at factor cost.
c. Expenditure method: in this method, national income is measured as a flow of expenditure. GDP is sum-total of private consumption expenditure.
3a. Relative income hypothesis.
b. Life cycle hypothesis.
c. The permanent income hypothesis.
d. The absolute income hypothesis.
a. Relative income hypothesis: this theory states that an individual’s attitude to consumption and saving is dictated more by his income in relation to others than by abstract standard of living.
b. Life cycle hypothesis: this is an economic theory that describes the spending and saving habits of people over the course of a lifetime.
c. Permanent income hypothesis: this is a theory of consumer spending stating that people will spend money at a level consistent with their expected long term average income.
d. The absolute income hypothesis: this theory concerns how a consumer divides his disposable income between consumption and saving.
4. The multiplier: this is a simple factor that amplifies or increase the base value of something else.
It refers to an economic factor that when changed, causes changes many other related economic variables.
5. The accelerator principle: this is an economic concept that draws a connection between fluctuation in consumption and capital investment. It states that when demand for consumer goods increases, demand for equipment and other investments necessary to make these goods will grow even more.