Keynes’ Concept of National Income

Read this article to learn about the Keynes’ concept of national income.

The concept of national income has undergone considerable improvement in the hands of J.M. Keynes. He developed aggregate analysis of income and employment.

He suggests three approaches to income concept:

(a) The first is from the standpoint of total expenditures on consumer goods and investment goods called income-expenditure approach;

(b) The second is from the standpoint of the incomes of the various sectors of production called factor income approach; and

(c) The third is from the standpoint of aggregate sales minus the costs of production called sale proceeds minus costs approach.

The Expenditure Approach is Summed up in the Equation:

(A – A₁) + (G’ – B’ – G) = Y; the factor income approach is summed up in the equation F + E_p= Y; and the third approach in the equation A – U = Y or A – U – V = Y.

G’- B ‘may be conveniently called K. K,—that is (G’- B’) represents the net value of capital goods carried over from the previous production period before anything is spent on its maintenance and improvement. It is the net value of capital inherited from the previous period. G is actual value of capital equipment at the end of the production period. Thus, K – G is the capital consumption.

If G (capital equipment at the end of the production period) is equal to K (capital equipment at the beginning of the period), then gross investment for the period in question would just equal capital consumption; and so net investment would be zero. If, however, G is greater than K, then net investment in capital has occurred equal to G – K. Thus, if A – A₁ = consumers outlays or C; while G – K = net investment or I, then:

(A – A₁) + (G – K) = C + I = Y.

This is the first method of arriving at national income according to Keynes.

F is the sum paid to the factors of production and E_p is the income (net profit) of entrepreneurs.

Together these equal income:

Y = F + E_p.

This is the national income at factor cost. Here F shows the sum of the receipts of the factors of production like land, labour, capital or what is called sum of distributive shares and E_p shows the entrepreneurial profits.

Now capital consumption (K – G) plus the purchase of raw materials (Ai) made during the production period are equal to what Keynes calls user cost (U). Thus, (K – G) + A₁ = U. Capital consumption plus materials is the user cost of production in the aggregate goods sold (A). Now the aggregate goods sold minus user cost (capital consumption plus materials used) will equal the national income. Thus, A – U – Y is the sales minus cost approach.

Keynes’s real concept of national income lies somewhat midway between Gross National Product and Net National Product. Keynes does not deduct the whole amount of depreciation from the Gross National Product, he subtracts a little less than the whole amount of depreciation called ‘User Cost’. It is the cost of using capital equipment rather than leaving it idle. User cost is the difference between the depreciation in the value of the machine when it is put to use and the depreciation which would occur if not in use plus the expenditure incurred—on its maintenance and upkeep.

For example, a machine worth Rs. 1,000 in the beginning of the year remains worth Rs. 750 at the end of the year having suffered a reduction in the value worth Rs. 250 as a result of depreciation. Even if the machine was not put to use, it would have suffered a loss of value on account of say rusting etc. But in this case the value of the machine has been maintained at Rs. 900 at the end of the year by including a small maintenance cost of Rs. 10. Thus, the user cost would be Rs. 250 – (Rs. 100 + Rs. 10) = Rs. 140.

In this way, by adding together the user costs of all the firms in the economy, we get the aggregate user cost of the whole economy. When we deduct the aggregate user cost from the Gross National Product, we shall get national income of the economy in the Keynesian sense represented by A – U where A is the Gross National Product, being the total produce or value of goods and services obtained in a year and U represents the total user cost). According to Keynes, number of people to be employed (N) depends upon income (K) in this sense.

Keynes, however, felt that the concept of income in terms of A – U is of little use when the community has to decide how much to spend on consumption. Thus, the idea of ‘net income’ assumes special significance. Net income is found by deducting supplementary costs (V) from the income (A – D). Thus, net income = A – U – V.

In other words, both the user costs (U) and supplementary costs (V) have to be subtracted from Gross National Product (A) to obtain the net national income. Supplementary costs are those costs which cannot be foreseen or are beyond the control of entrepreneurs, i.e. these are contingent costs like plant becoming obsolete, catching fire, etc.

Even if the entrepreneur wished, he could not avoid this loss. Such costs have to be deducted from gross income to get net income, on which the consumption of the community depends. Since consumption depends upon net income, it is necessary that net income must be calculated as accurately as possible. To conclude, Keynes uses the term income in two senses—gross income (A – U) on which the volume of employment depends, net income (A – U – V) on which consumption of the community depends.

Let us be clear that there are many acceptable ways of defining the national income, and there is nothing absolutely right or wrong about any of these definitions. The essential thing is to realize how it is defined in each case and to choose the most suitable definition for any particular purpose. Which particular definition of national income is relevant in a study of macroeconomics will depend upon the nature of the problem and the purpose for which data is being computed.

If, for example, we want to know and compare the economic welfare of different years in a country’s development, then, the quantum of goods and services consumed would be a better index to use; but if we want to know the causes affecting economic welfare, then the long term effects of capital depreciation and productive capacity of the country will be more vital to the analysis.