National Income and AD/AS Analysis: Question 10

Worked solution

Step 1: Recall how GNI is derived from GDP

$GNI = GDP + \text{net income from abroad}$

where net income from abroad is (income earned by domestic residents and firms from assets held overseas) minus (income earned by foreign-owned residents and firms from assets held domestically). GNI is lower than GDP only when this net income from abroad figure is negative. That is, when more income leaves Economy Y to foreign owners than flows in from Economy Y’s own overseas assets.

Step 2: Check option A

Option A describes exactly this situation: income earned by foreign-owned firms and residents operating inside Economy Y (which must be paid out to those foreign owners) exceeds income earned abroad by Economy Y’s own residents and firms (which flows back in). This makes net income from abroad negative, so:

$GNI = GDP + (\text{negative net income from abroad}) < GDP$

Here, $480 = 500 + (-20)$, confirming a net outflow of $20 billion in income to foreign owners. This matches option A.

Step 3: Rule out options B, C and D

• Option B: describes the opposite situation. Economy Y’s residents earning more abroad than foreigners earn inside Economy Y would make net income from abroad positive, so GNI would be higher, not lower, than GDP.
• Option C: depreciation is subtracted when moving from GNI to Net National Income (NNI), a separate step that comes after GNI has already been calculated; it has no bearing on why GNI itself is lower than GDP.
• Option D: the government’s own budget balance (taxation versus government spending) is a fiscal policy matter, unrelated to cross-border flows of factor income between Economy Y and the rest of the world.

Final answer

Option A. GNI is lower than GDP here because income paid out to foreign-owned factors of production inside Economy Y exceeds income earned by Economy Y’s own residents and firms from assets held abroad, making net income from abroad negative.