TOPIC 7: NATIONAL INCOME
INTRODUCTION
National income refers to the total income earned by owners of factors of production. Incomes
earned by factors of production may constitute:
Rent
Salaries/wages
Interest
Profit
National income is measured by the government after a given period of time usually one year
TERMS USED IN NATIONAL INCOME
a) Gross domestic product (G.D.P)-G.D.P refers to the total money value of all goods and
services produced within a country over a given period of time. Note that G.D.P excludes
incomes from abroad
b) Net domestic product (N.D.P)-N.D.P refers is equal to G.D.P less depreciation on capital
goods used to produce goods and services
N.D.P=G.D.P-Depreciation
c) Gross national product (G.N.P)-G.N.P refers to the monetary value of all goods and services
produced by citizens of the country both from within the country and from overseas countries
G.N.P=G.D.P + Net income from abroad
Net income from abroad=Exports-Imports
d) Net national product (N.N.P)-N.N.P refers G.N.P less depreciation on capital equipment used
in production
N.N.P=G.N.P-Depreciation
e) Per capita income
Per capita income refers to the average income per head per year in a country. It is calculated
as follows:
Per capita income=National income ÷ Total population
f) Personal income (P.I)
This is the sum of all incomes received by the residents of a country during a year
g) Disposable personal income (D.P.I)
This is the income that an individual or a resident of a country receives after paying direct taxes
to the government
THE CIRCULAR FLOW OF INCOME
This Refers to the movement of money in an economy.
Households spend their money by buying goods and services produced by firms. Firms on the
other hand spend their money on paying for factors of production provided by households
Note that for the circular flow of income to exist, the following conditions should be met:
There are only two players in the economy i.e. firms and households
There is no foreign trade
There is no government interference
Firms spend all their incomes on factors of production
Households spend all their incomes on goods and services
All goods and services produced are bought
A person or a firm cannot be a producer and a consumer at the same time
FACTORS AFFECTING THE FLOW OF NATIONAL INCOME
In the circular flow of income illustrated above, we are assuming that consumers spend all their
money on buying goods and services whereas firms spend all their money on paying for factors
of production. In reality this may not be the case since consumers save part of their income
while firms pay part of their income as tax. The following factors will therefore affect the
amount money flowing between firms and households
a) Savings-Savings refers to that part of income that is kept for future use. Savings by
households reduces the amount of money reaching firms hence reducing amount of
money in the circular flow
b) Government -The government may also influence the amount of money changing hands
between firms and households in two ways
Taxation: taxation reduces amount of money available for spending by firms therefore
reducing amount of money in the circular flow
Government expenditure: government expenditure introduces more money to the
economy. This may be through giving subsidies, buying products from firms or paying
salaries to consumers. Government expenditure will therefore increase the amount of
money in the circular flow.
c) Investment -Investments refer to amount spent by firms on buying capital goods such
as machines from households. Investments therefore ensures additional incomes for
households hence increasing money in the circular flow
d) Foreign trade-Foreign trade constitutes exports and imports. Exports earn income to
the country; they therefore increase money in the circular flow. On the other hand
imports withdraw money from the economy therefore reducing money in the circular
INJECTIONS AND WITHDRAWALS
Injections: Refers to factors that introduce additional moneys in the circular flow of
income. They constitute:
a) Investments
b) Government expenditure
c) Exports
Withdrawals: Refers to those factors which reduce the amount of money in the circular
flow of income. Also known as leakages. They constitute:
a) Savings
b) Taxes
c) Imports
NATIONAL INCOME EQUILIBRIUM
Equilibrium in national income is achieved when total injections equal total withdrawals.
At this point, the economy is at balance
National income equilibrium equation can therefore be given as:
S+T+M=I+X+G
Where:
S=savings
T=taxes
M=imports
I=investments
X=exports
G=government expenditure
MEASURTEMENT OF NATIONAL INCOME
National income can be measured using either of the following methods
Expenditure approach
Income approach
Output approach
1. Expenditure approach
Using this approach, national income is arrived at by adding all expenditures incurred in the
economy on final goods and services
NOTE: Final goods and services refer to those goods and services which are meant for final
consumption i.e. not for use as raw materials
Using this approach therefore, the following expenditures are added to arrive at national
income:
Consumption expenditure: Refers to expenditure by consumers. Denoted using
letter C
Investment expenditure: Refers to expenditure by firms. Denoted using letter I
Government expenditure: refers to expenditure by the government. Denoted
using letter G
Net expenditure on exports: refers to total expenditure incurred when exporting
goods. Represented by (x-m)
(x-m) means exports – imports
This approach gives national income at market prices
NOTE:
Expenditure approach calculates national income by adding the market prices at which different
goods are bought; these market prices can be influenced by subsidies and taxes.
The market price of products may also be influenced by depreciation.
When calculating national income using expenditure approach, taxes, subsidies and
depreciation has to be taken into consideration
Therefore national income using expenditure approach is given as follows:
National income=C+I+G+(x-m) +subsidies-taxes-depreciation
Problems associated with expenditure approach
a) Lack of expenditure records especially in the private sector
b) Expenditure in the subsistence sector can only be estimated since no accurate records
are available
c) Difficulty in distinguishing between final and intermediate expenditures
d) Double counting of expenditures may result
e) Changes in foreign exchange rates may affect valuation of imports and exports
f) Incorrect values of government expenditure
2. Income approach
This approach sums up all incomes received by those individuals who take part in the
production of goods and services (personal income) and the income received by the
government on its investments (public income).It gives national income at factor prices.
Incomes received by individuals constitute:
Rent
Interest
Wages
Profit
Incomes received without working are excluded from the calculation of national income. These
incomes are known as transfer payments are may include:
Insurance compensations
Pension payments
School fees
Bursary allocations and grants to needy students
Grants from friends
Students’ pocket money
Transfer payments if included may constitute double counting
Therefore national income using income approach is given as follows:
National income=Personal income + public income + retained profit + appreciation - transfer
payments – depreciation
Problems associated with income approach
Difficulty in identifying and value amount constituting transfer payments so as to
exclude them from the calculation of national income
Lack of accurate data on incomes since businesses will state lower incomes in order to
pay less taxes
Changes in prices of commodities affects profits earned by firms
Difficulty in identifying incomes from illegal activities such smuggling which is to be
excluded from national income
It is difficulty to obtained statistics on the total earned by the government
3. Output (value added) approach
Using this approach, national income is arrived at by adding the values of all final goods and
services produced by firms in a given year
National income may also be arrived at by adding the value added on different products for
example if A sells a product to B at Ksh 40,B sells it to be at Ksh65, and C sell it to D at Ksh
90,then value added Is calculated as follows:
Value added by A = Ksh40
Value added by B = Ksh (65-40) = Ksh 25
Value added by C = Ksh (90-65) = Ksh 25
Total value added (national income) = Ksh 90
Note: Ksh 90 equals total output
The value of goods and services produced from abroad is also included in the calculation of
national income. Therefore using this approach, national income is given as follows:
National income=GDP+(x-m)-depreciation
Problems associated with the output approach
Lack of accurate output figures especially in the private sector
Difficulty in identifying value of illegal activities to be excluded
Difficulty in valuing government output which does not reach the market
Changes in market prices making valuation difficult
Problems in differentiating between final and intermediate products
Difficulty in valuing output from the subsistence sector
USES OF NATIONAL INCOME STATISTICS
National income statistics refers to the information gathered from different sources of national
income. This information has the following uses:
a) Indicates the standard of living-Standard of living refers the quality of life of people in
an economy. Standard of living is influenced by the levels of income. The level of
national income therefore has a direct impact on standards of living in the sense that
the higher the national income, the better the standard of living and vice versa.
b) Enables comparison of living standards in different countries- Levels of national income
are used to compare which country is more developed and therefore has better living
standards than the other .A country with high national income level is assumed to enjoy
better living standards. Sometimes however high national income levels may not reflect
improved standards of living due to the following factors:
Differences in currency rates
Differences in goods and services used to compute national income in different
countries
Differences in equality in income distribution
Differences in needs, tastes and preferences
c) Facilitates the assessment of economic performance over time- By comparing national
income levels at different periods, information is provided on the period of the year the
economy was doing well
d) Facilitates economic planning-The government will use information on national income
to come up with plans on how grow the economy
e) Enables entrepreneurs make investment decisions-Investors will use information on
national income level to make decisions on which markets and sectors to invest in. This
is because a higher national income means more per capita incomes hence high market
demand and vice versa. Information on national income also enables investors know
which sectors in the economy are doing better than others
FACTORS INFLUENCING THE LEVEL OF NATIONAL INCOME
a) Supply of labour-Labour supply refers to the quantity and quality of a country’s
workforce. The higher the number of workers, the higher the output hence more
national income. On other hand, with skilled labour, high quality goods and services
which generate higher national incomes will be produced
b) Amount and quality of capital-Capital refers to tools and equipment used in production.
When capital is of high quality, output will be high hence more national income is
earned unlike when poor quality goods are used
c) Level of entrepreneurship-Availability of entrepreneurs who have the ability to organize
the factors of production in the right proportions to produce goods and services will
influence the level of national income .A country with efficient entrepreneurs is likely to
produce more and increase its level of national income as compared to a country with
inefficient entrepreneurs.
d) Availability of land-Land contains all the natural resources required in production,
therefore a country with enough land will produce more and increase its level of
national income
e) Level of technology-Technology refers to the techniques used in the production of
goods and services. The higher the level of appropriate technology, the higher the
output and hence higher national incomes
f) Political stability-A country with peace and stability is likely to encourage investors who
will contribute greatly in increasing the level of national income
g) Attitude of citizens towards work-A country with hardworking citizens will have high
levels of national income compared to a country with lazy citizens
h) Size of the subsistence sector-Subsistence sector refers to those who produce goods for
consumption purposes. When the subsistence sector is large, amount of goods and
services produced for sale will be low hence reducing the level of national income
i) Level of foreign investment-Level of foreign investment refers to the number of foreign
investors in a country. Increase in foreign investment therefore increases production
thereby raising the level of national income