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Growth Rate Of National Income

Info: 1653 words (7 pages) Essay
Published: 12th May 2017 in Economics

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National income can be defined as the part of the objective income of the community including income derived from abroad which can be measured in money i.e the money value of goods and services which is produced and made available for consumption in an economy for a particular period which is usually a year. National income is usually denoted as Y and is measured in countries to see the rate at which the economy grows as well as the changes in average living standards and changes in the distribution of income between groups in the population. National income is measured using Gross Domestic Product (GDP). Below is the national output of the United Kingdom measured in GDP from 1990-2012.


Tracking UK economic activityThe full equation for calculating GDP is; Y=C+I+G+(X-M)

Where C=household spending/ consumption

I = capital investment

G= government spending

X= exports of goods and services

M= imports of goods and services.

There are three methods that can be used to calculate GDP and they are;

The expenditure method

The income method

The value added method.

The limitations of using the GDP to calculate National Income is that even though it measures economic activity it is not the same as economic wellbeing because it measures only goods and services that are priced and sold in markets such as leisure time and other non-market economic activities.

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There are two main theories that discuss the role of various factors that determine economic growth; the neo-classical theory which is based on Solow’s growth model which talks about investment and savings and also emphasizes that increase in inputs say labour and capital would increase national income and also the theory of endogenous growth by Romer and Lucas such as the AK model which emphasizes that human capital, innovation capacity and knowledge have contributed greatly to the growth rate of national income (Petrakos et al, 2007).


The neoclassical theory based on Solow’s growth model (1956) emphasizes that the increase in inputs i.e labour and capital and technical progress are the determinants of economic growth. It also gives an overview of how savings affect the economy over time. The Solow model takes on the assumptions of Harrod-Domar model except the assumption of fixed proportions of input. The model states that there is only one good produced in an economy (Yt) and some of it is consumed (Ct) while the rest is saved (St). The economy is assumed to be a closed one so savings equal investment and the good is produced by Labour (Lt) and Capital (Kt). So we have the production function; Given the model, Yt =F ( Kt, AtLt);

Where Yt is the output, Lt is the rate of population growth, At is the technological progress, Kt is the law of motion of capital stock; It – δKt, δ is depreciation, I is investment, and Saving-Investment Balance: St=Yt=It.



Source: en.wikipedia.org

Its limitations are that there is that every key variable is constant; we can still access the model as valid to some extent since the result provided from this model is not wrong. The model shows that output cannot permanently grow faster than population but this could be because of the structure of the model. The model is a simplified one but it sheds light on other studies using neo-classical tools.


The endogenous theory holds that investing in human capital, innovation and knowledge are significant contributors to economic growth. It also focuses on the externalities of a knowledge-based economy which is economic development. The theory also emphasizes on the long run growth rate of an economy. The AK model is given as;


Where A is a positive constant that reflects the level of the technology and K is capital i.e human capital.

y=AK, output per capita and the average and marginal product are constant at the level A>0.

The endogenous growth model holds that knowledge driven groth can lead to a constant or an increasing rate of return.


Source: en.wikipedia.org

With endogenous models, per capita growth depends on behavioural factors of the models same as the saving rate and the population, this is different from the neo-classical models where higher savings promote higher long run per capita growth.


A framework for the determinants of economic growth was provided by Barro (1997);

g= f(y, y*)

Where g is the growth rate of per capita output (GDP), y is the current level of per capita output, and y* is the steady-state level of per capita output. At y*, the level of output per worker still increases because of exogenous labour-augmenting technological innovations, even though output per effective labour remains constant. It is difficult in real life to obtain steady-state level of output as it is determined by economic, social, cultural, demographic, political structures, savings and consumption patterns. At y*, increase in output decreases its growth rate because of diminishing returns. Given the current output level y, improvements in exogenous conditions favourable to the economy would cause an increase eventually in equilibrium level of output y* which will increase the growth rate of output.

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Based on the research carried out by Chen and Feng (1999), it was discovered that human capital, fertility, trade, government consumption, state-owned enterprises, inflation and terms of trade were determinants of economic growth in China. The researchers used a cross-country analytical approach which requires averaging the values of the relevant variables for fairly long period of time and the advantage is that it allows them examine long-run trends of economic growth. The results was that education, industrialization and international trade had positive effect on growth, state-owned enterprises, birth rates and inflation had negative effects while investment was insignificant.


Recently, there has been causal evidence of the link between income and health. Just as the poor cannot afford healthcare such as vaccinations, drugs and so on, cannot afford nourishing food and education so also an unhealthy person would not be able to go to school frequently or assimilate well thus human capital would not increase and labour outcomes will be low (Bloom et al, 2000). Hence a country with so many unhealthy people would not be able to grow.


Rate of inflation is the rate of change in price level over a year. Inflation is the persistent increase in price level within a year. This has a negative effect on the growth rate of national income. If inflation increases, prices will be high lowering growth rate.


The labour market includes the total number of those employed and those who are not in the economy. An increase in labour will lead to increase in productivity thereby increasing national income.


Investment is financed by saving while saving is a constant fraction of income. The stock of physical capital increases over time because of investment in new capital goods e.g. factories (McDowell et al, 2012).


This is an improvement in knowledge which makes it possible to produce higher output from existing resources i.e capital and labour. This is also known as technology, it has lead to growth in productivity and national income.


Openness to trade is a major determinant of the growth rate of national income. International trade affects growth positively through channels like exploitation of comparative advantage, transfer of technology and knowledge diffusion, increasing scale economies and exposure to competition.


This is regarded as workers acquisition of skills and know-how through education and training. Baro (1991) says that educated population is a major determinant of economic growth.


This refers to a situation where there is constant growth and low inflation leading to increased productivity, improved efficiencies and low unemployment.


Government also plays important role in the growth of national income by putting policies in place such as stabilization policy, monetary policy and fiscal policy. Political instability would hinder the progress of an economy but if there is political stability production would be maintained at a high level and national income will increase.


An increase in the quantity of goods and services produced by an economy through technical progress and human capital will lead to an increase in national income.


The level of infrastructural development such as good roads, increased technology, light and other basic amenities in a country can determine the growth rate of national income by increasing the level of production, trade, immigration thereby increasing labour force and increase in number of entrepreneurs increasing the productive capacity of a country.



In conclusion, health, saving and investment, human capital, technical progress, economic status, factors of production and so many other factors are determinants of the growth rate of national income.


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