Mr. Lee is a previously self-employed man with an income of $3,500. He decided to become an employee of a manufacturing company with a salary of $4,000. In closing down his business, two of his employees were dismissed, each previously receiving a salary of $1,000. Each of his employees will now receive unemployment benefits worth $500 per annum.
What was the change in national income as a result?
Income Approach to GDP:
The income approach is one of the three approaches to calculating gross domestic product. Under this approach, aggregate output is calculated as the sum of payments to different factors of production in the economy, including profit.
Answer and Explanation:
Before the business is closed down, the total income is the sum of profit (self-employed income) and salaries of two employees, i.e.,
- total income = 3500 + 1000 * 2
- total income = 5500
After the business is closed down, the only income is the salary to Mr. Lee, which is 4000. Note that the unemployment benefits are not part of income for the purpose of calculating GDP, because they represent transfers of payments, but income earned from providing factors of production. Hence, total income after the business is closed down is 4000.
Thus the change in national income = 4000 - 5500 = -1500.
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from Economics 102: MacroeconomicsChapter 4 / Lesson 2