Macroeconomics Concepts: National Income and Fiscal Policy

Posted on Sep 8, 2026 in Economy

1. Define National Income

National Income refers to the total factor income earned by the normal residents of a country from the production of goods and services during a financial year. It includes wages, rent, interest, and profits earned by the factors of production.

Formula: National Income = NNP at Factor Cost

2. Difference Between GDP and GNP

GDP (Gross Domestic Product) is the money value of all final goods and services produced within the domestic territory of a country during a given period.

GNP (Gross National Product) is the money value of all final goods and services produced by the normal residents of a country, whether production takes place within or outside the country.

Formula: GNP = GDP + Net Factor Income from Abroad (NFIA)

3. Real GDP vs. Nominal GDP

  • Nominal GDP: Measures the value of final goods and services at current market prices.
  • Real GDP: Measures the value of final goods and services at constant or base-year prices.

Nominal GDP is affected by price changes, whereas Real GDP reflects changes in actual output.

4. Causes of Demand-Pull Inflation

Demand-pull inflation occurs when aggregate demand exceeds aggregate supply. Main causes include:

  • Increase in money supply and credit
  • Increase in consumer expenditure
  • Increase in government expenditure
  • Increase in private investment
  • Increase in exports

5. Consumption Function

The Consumption Function expresses the functional relationship between consumption expenditure and disposable income. The Keynesian function is:

C = a + bYd

Where: ‘a’ is autonomous consumption, ‘b’ is MPC, and ‘Yd’ is disposable income.

6. Involuntary Unemployment

Involuntary unemployment is a situation where people are willing and able to work at the prevailing wage rate but are unable to find employment. According to Keynes, it arises due to an insufficiency of aggregate demand.

7. Investment Function

The Investment Function shows the relationship between investment expenditure and its determinants, particularly the rate of interest and expected profitability. Generally, investment has an inverse relationship with the rate of interest.

8. Investment Multiplier

The Investment Multiplier measures the change in national income resulting from a change in autonomous investment.

K = ΔY / ΔI

In a simple Keynesian model: K = 1 / (1 − MPC) = 1 / MPS

9. Government Expenditure Multiplier

The Government Expenditure Multiplier measures the change in national income resulting from a change in government expenditure.

Kg = ΔY / ΔG = 1 / (1 − MPC)

10. Inflationary Gap

An Inflationary Gap is the excess of aggregate demand over the aggregate demand required to maintain full-employment equilibrium. It creates upward pressure on the general price level.

Inflationary Gap = Actual AD − Full-employment AD

11. Causes of Cost-Push Inflation

Cost-push inflation occurs when the cost of production increases. Major causes include:

  • Rise in wages
  • Increase in raw-material prices
  • Increase in fuel and energy costs
  • Increase in indirect taxes
  • Shortage of essential inputs

12. Disposable Personal Income

Disposable Personal Income (DPI) is the income available to households for consumption and saving after payment of personal direct taxes.

DPI = Personal Income − Personal Direct Taxes

13. Definition of Inflation

Inflation is a sustained and general increase in the overall price level of goods and services in an economy over time, which decreases the purchasing power of money.

14. Two-Sector Circular Flow of Income

The circular flow of income refers to the continuous movement of income, expenditure, and output between households and firms.

  • Real Flow: Factors of production move from households to firms; goods and services move from firms to households.
  • Money Flow: Factor payments move from firms to households; consumption expenditure moves from households to firms.

15. Three-Sector Circular Flow of Income

A three-sector economy includes households, firms, and the government. Taxation (T) acts as a leakage from the circular flow, while government expenditure (G) acts as an injection.

16. IS-LM Framework Equilibrium

The IS-LM framework explains the simultaneous equilibrium of the goods market (IS) and money market (LM).

  • IS Curve: Downward sloping; represents goods market equilibrium (Y = C + I + G).
  • LM Curve: Upward sloping; represents money market equilibrium (M/P = L(Y,r)).

The economy reaches equilibrium where the IS and LM curves intersect.

17. Fiscal and Monetary Measures to Control Inflation

Fiscal Measures:

  • Reduction in government expenditure
  • Increase in taxes
  • Reduction in fiscal deficit

Monetary Measures:

  • Increase in interest rates
  • Open market operations (selling securities)
  • Increase in reserve requirements
  • Credit control

18. National Income Calculation Example

Steps:

  1. GNP = GDP + NFIA
  2. NNP at MP = GNP − Depreciation
  3. Net Indirect Tax = Indirect Tax − Subsidies
  4. NNP at FC (National Income) = NNP at MP − Net Indirect Tax

19. Effect of Increased Investment on IS Curve

An increase in autonomous investment raises equilibrium income at any given interest rate. Consequently, the IS curve shifts to the right, indicating a higher equilibrium level of national income.