Net Income

My definition of net income:

• is very close to Marshall’s definition
• corresponds to the money value of Professor Pigou’s most recent definition of the National Dividend.[5]

Net income is based on an equivocal criterion which different authorities might interpret differently, is not perfectly clear-cut.

Professor Hayek thinks that an individual owner of capital goods might set aside savings to offset any decline of his investment-income. In this way, his income from capital goods remains constant .[6]

• I doubt if such an individual exists.

Professor Hayek’s concepts of saving and investment are vague -. He is only right if he means net saving and net investment.

Thus it is wrong to put all the emphasis on net income.

• It is only relevant to decisions concerning consumption.
• It is only separated from various other factors affecting consumption by a narrow line.

People usually overlook the concept of income properly.

My previous definition of income in my Treatise on Money is refers to the part of aggregate income which accrues to entrepreneurs.

• This is because that definition did not take actual or expected gross or net profit from business operatios.
• Instead, it refers to a normal or equilibrium profit
• It meant that saving exceeded investment by the excess of normal profit over the actual profit.

This use of terms has caused considerable confusion, especially in the case of savings.

I thus discard my previous definitions with regret for the confusion which they have caused.

**Saving is the excess of income over expenditure on consumption. **

Expenditure on consumption is the value of goods sold to consumers during that period.

What does consumer-purchaser mean? Should we regard the purchase of a car as a consumer-purchase, and that of a house as an investor-purchase?

This is answered by drawing the line between the consumer and the entrepreneur.

Purchases is the value of what one entrepreneur has purchased from another.

Expenditure on consumption = Summation of Sales - Summation of Purchases

U is the aggregate user costs of the entrepreneurs.

Income = Sales - User Cost

Consumption = Sales - Purchases

Savings = Purchases - User Cost

Net saving is the excess of net income over consumption:

Net saving = Purchases - User Cost - V

Our definition of income also leads to the definition of current investment.

• This means the current addition to the value of the capital equipment which has resulted from the productive activity of the period.
• This is equal to what we have just defined as saving.
• For it is that part of the income of the period which has not passed into consumption.

After production, entrepreneurs end up with:

• Sales
• capital equipment which has suffered a deterioration measured by User Cost (or an improvement measured by -U where U is negative)
  • This is a result of having produced and parted with Purchases after allowing for purchases 1 from other entrepreneurs.

Finished output having a value Sales - Purchases will have passed into consumption.

The excess of Sales - User Cost over Sales - Purchase , namely A1 - U, is the addition to capital equipment as a result of the productive activities of the period and is, therefore, the investment of the period. Similarly A1 - U - V is the net addition to capital equipment, after allowing for normal impairment in the value of capital apart from its being used and apart from windfall changes in the value of the equipment chargeable to capital account, is the net investment of the period.

While the amount of saving is an outcome of the collective behaviour of individual consumers and the amount of investment of the collective behaviour of individual entrepreneurs, these two amounts are necessarily equal, since each of them is equal to the excess of income over consumption.

Moreover, this conclusion in no way depends on any subtleties or peculiarities in the definition of income given above. Provided it is agreed that income is equal to the value of current output, that current investment is equal to the value of that part of current output which is not consumed, and that saving is equal to the excess of income over consumption — all of which is conformable both to common sense and to the traditional usage of the great majority of economists — the equality of saving and investment necessarily follows. In short— Income = value of output = consumption + investment.

Saving = income - consumption

Therefore saving = investment. Thus any set of definitions which satisfy the above conditions leads to the same conclusion. It is only by denying the validity of one or other of them that the conclusion can avoided. The equivalence between the quantity of saving and the quantity of investment emerges from the bilateral character of the transactions between the producer on the one hand and, on the other hand, the consumer or the purchaser of capital equipment.

Income is created by the value in excess of user cost which the producer obtains for the output he has sold; but the whole of this output must obviously have been sold either to a consumer or to another entrepreneur. Each entrepreneur’s current investment is equal to the excess of the equipment which he has purchased from other entrepreneurs over his own user cost.

Saving is the aggregate excess of income over consumption.

Investment is the addition to capital equipment.

This is the same with net saving and net investment.

Saving is a mere residual.

The decisions to consume and invest determine incomes.

Invest or selling curtails consumption or buying.

There are times when equilibrium is reached wherein the readiness to buy is equal to the readiness to sell.

A market value for output is necessary:

• for money-income to possess a definite
• for the aggregate savings in society to be equal to the aggregate investments made by that society.

It is easier to think in terms of decisions to consume rather than of decisions to save.

A decision to consume or to invest is a personal choice.

Aggregate income comes from the decision to invest or not.

Aggregate saving comes from the descision to consume or not.

The propensity to consume will take the place of the propensity to save.

Author’s Footnotes

3. Supply price is incompletely defined if user cost has not been defined.

The exclusion of user cost from supply price is sometimes appropriate in the case of aggregate supply price. But it is inappropriate to the problems of the supply price of a unit of output for an individual firm.

4. For example, let us take Zw = φ(N), or alternatively Z = W. φ(N) as the aggregate supply function (where W is the wage-unit and W.Zw = Z).

Then, since the proceeds of the marginal product is equal to the marginal factor-cost at every point on the aggregate supply curve, we have ΔN = ΔAw - ΔUw = ΔZw = Δφ(N), that is to say φ'(N) = 1 provided that factor cost bears a constant ratio to wage-cost, and that the aggregate supply function for each firm (the number of which is assumed to be constant) is independent of the number of men employed in other industries, so that the terms of the above equation, which hold good for each individual entrepreneur, can be summed for the entrepreneurs as a whole.

This means that, if wages are constant and other factor costs are a constant proportion of the wages-bill, the aggregate supply function is linear with a slope given by the reciprocal of the money-wage.