DBM 614: Economics Topic 6: National Income

National income is a measure of the total monetary value of flow of final goods and services arising from
productive activities of a nation in a given year. It is distributed among the factor inputs in the form of rent,
wage, interest and profits.

Definitions and concepts of national income

[Link] domestic product (GDP)- is the money value of total goods and service produced annually in a
country using exclusively the resources of that country.
[Link] national product (GNP)- is the money value of all the economic productions in the economy during
one year. It includes all the factor incomes from abroad.
GNP=GDP + Net factor income from abroad
=GDP + (Total exports – Total imports)
[Link] national product (NNP) – is the money value of all the economic productions in the economy,
adjusted for the value of capital consumed (depreciation of capital assets) during the year. It's also
referred to as National Income at market price.
NNP=GNP-Depreciation
[Link] National Income (NNI)/ National Income at Factor cost- is the total of all income payment received
by the factor inputs- land, labor, capital, enterprise and organization during one year. It tells us how the
national output is distributed amongst the various factor inputs in lien of the services rendered by them. It
is closely related to the concept of economic justice.
NNI= NNP-Indirect +subsidies.
[Link] income (PI) – Is the total income actually available for distribution amongst the individuals or
households in a country during one year. The whole of the national income earned by the factor inputs in
one year is not available to them because several deductions are made out of it and some allowances are
given for non-productive work.
PI= NNI- Corporation tax – retained profit – contribution Benefit from social security schemes+transfer
payment + benefit from social security schemes.
[Link] personal income (DPI)- is the income of individuals available for consumption (after payment
of personal direct taxes)
DPI= PI –personal direct taxes.
[Link] capital income – is the income of the year distributed per unit of population.
= NNI for the given year
Population during that year
[Link] net national income ( real NNI)- IS the NNI of a country for a given year expressed in terms of the
constant price the price prevailing in the base year.
= NNI for a given year ×100
Cost of living index
[Link] per capital income - is the ratio of the real net national income for the given year to the size of the
population of the economy during the year.
= Real NNI for a given year
Population during that year.

Compiled by CPA Nyamanya +254 700 693 826: enyamanya@[Link] Page 1 of 9

 DBM 614: Economics Topic 6: National Income

Determinant of national income

[Link] stability – a conducive local political atmosphere attracts both local and foreign investors
leading to an increase in the size of national income.
[Link] of technology – Technology refers to the methods used in production of goods and in service
delivery. The effectiveness and speed of methods used in production and service delivery determines
both the quality and quantity of goods and services produced.
[Link] resources endorsement – The more the natural resources available in terms of land, mineral and
oil deposits, water sources, among others, the higher the opportunities for exploitation of such resources
with a profit motive.
[Link] supply (the quantity and quality of workforce) available in country. A country with more skilled
labour force would be expected to produce more and higher quality goods and services than a country
with less skilled labour force.
[Link] culture – in a country where people have an enterprising culture, there will be more
creativity and innovation resulting to new and improved goods and services to generate more national
income.
[Link] factors:
a. Consumption
[Link].
c. Investment.

Consumption
As income increase, the level of consumption increases. However, the increase in consumption may not be
proportionate to the increase in income since some of the extra income may be spent and some saved.

Factors affecting consumption

[Link] of income – the higher the level of income the higher the rate of consumption.
[Link] and social pressure – advertising and the desire to keep up with one’s neighbours causes
consumption to be higher than otherwise would have been.
[Link] of future unemployment – when people expect to become unemployed in the near future,
they may decide to spend less and save more.
[Link] redistribution – if income is redistributed from the rich to the poor then total consumption might
be expected to rise.
[Link] of future price changes – when people expect future price to increase, it will increase current
consumption and vice versa.
[Link] of interest – consumers will save more and spend less when interest rates are high.
 Availability of consumer credit– if credit is more readily available and /or its cost is low, consumers are
more likely to borrow and thereby in the aggregate save less at all levels of aggregate disposal income. In
addition, a restricted lending policy reduces consumption while a liberal lending policy increases
consumption.
[Link] – a high level of income tax results to a decrease in disposal income and consequently a
decrease in consumption ( and vice versa ).

Compiled by CPA Nyamanya +254 700 693 826: enyamanya@[Link] Page 2 of 9

 DBM 614: Economics Topic 6: National Income

b. Savings
Is the proportion of income not spent on consumption.

Factors affecting savings

[Link] of income – the higher the level of income, the higher the chances of sparing part of the income in
form of savings.
[Link] of future unemployment – leads to more current savings and less consumption.
[Link] – a high level of income tax results to a decrease in disposable income and consequently a
decrease in savings (and vice versa)
[Link] of interest – consumer will save more when interest rates are high and vice versa.

C. Investments
Means expenditure on capital goods; that is, goods which are used in the process of production of other
goods and services.
Factors affecting investment
[Link] of interest – low rate of interest leads to an increase in investment activity and vice versa.
[Link] efficiency of capital asset over its cost. The higher the marginal efficiency of capital the higher
the inducement to invest. MEC may also be defined as the ration between the prospective yield of
additional capital goods and their supply price.(SP).
Example: If the SP of a capital is sh.200000 and its annual yield (PY) is [Link] MEC.
MEC = PY×100 = 20000×100=10%
SP 200000

Thus MEC is the percentage of profit expected from a given investment on a capital asset.

Types of investment
a. Induced investment – is investment motivated by the level of income when income increases,
consumption demand also increases and to meet this, investment increases. Induced investment is income
elastic.
Its further divided into:
 Average propensity to invest (API) – is the ratio of investment to income
API =Investment = I
Income Y
 Marginal propensity to invest (MPI) – is the ratio of the change in investment to the change in
income.
[Link] investment – is investment independent of the level of income and is thus income inelastic.
It is influenced by exogenous factors like innovation, invention, growth of population and labour force,
social and legal institutions, among other factors. It is not influenced by change in demand, but rather it
influences demand.
c. Private investment – is investment made by private investors. It is influenced by profit expectation and
marginal efficiency of capital.

Compiled by CPA Nyamanya +254 700 693 826: enyamanya@[Link] Page 3 of 9

 DBM 614: Economics Topic 6: National Income

[Link] investment – is investment made by the different levels of government. Public utility investment is
induced by demand for the same, while profit oriented government investments are induced by profit.
e. Gross and net investment – Gross investment is the increase in total capital assets in a year. Net
investment is the increase in total capital assets in a year after deducting depreciation and obsolescence
charges.
f. Intended and unintended investment- Intended investment – is a deliberate effort in or policy of
increasing existing inventory of capital. Unintended investment – is an increase in existing inventory of
capital due to involuntary/ unplanned occurrences.

Factors other than interest rate and the MEC affecting the inducement to invest
[Link] stock of capital goods – if it’s large, it would discourage potential investors from entering into
the production of goods. Also, is there is excess or idle capacity in the existing stock of capital goods,
there will be little or no inducement to investment.
[Link] of income - if the level of income in an economy rises through rise in money wage rate and other
factor prices, the demand for goods will rise which will in turn raise the inducement to inverse. ( and vice
versa)
-Inducement to invest will fall with the lowering of income level.
[Link] expectation – If the business person is optimistic with regard to future net returns from capital
assets, they will invest more -if they are pessimistic regarding future business prospects, the rate of
present investment will fall.
[Link] demand – demand current demand for consumer goods is increasing rapidly, more investment
will be made. If the consumer demand is low, less investment will be made.
[Link] assets – the inducement to invest is high for firms having large funds and undistributed profits.
The inducement to invest is low for firms and/ investors having little reserved funds in the form of liquid
assets.
[Link] of population – a growing population results in a growing market for goods in the economy thus
increasing the inducement to invest. A declining population results in a shrinking market for goods thus
lowering the inducement to invest.
[Link] policy – if the government levies heavy progressive tax on corporate profit the inducement to invest
is low. If the government levies relatively low tax on corporate profit the inducement to invest is high.
Heavy indirect taxation tends to raise the price of commodities and adversely affect their demand thereby
lowering the inducement to invest and vice versa. If the government provides an encouraging business
environment, such as by providing credit, power and other facilities, inducement to invest will be high
and vice versa.
[Link] climate- If there is political instability, the inducement to invest is often adversely affected. A
stable government creates confidence in the business community thus raising the inducement to invest.

Three methods of calculating national income.

[Link]/ output method- In these methods, the economy is classified into three major sectors whose
results are summed up to obtain national product or national income at market price. These are:
a. Industrial sector – where the value of goods produced in each production unit are added, valuation being
done at the market rate. A product census may be conducted to give the gross national product.
Compiled by CPA Nyamanya +254 700 693 826: enyamanya@[Link] Page 4 of 9
 DBM 614: Economics Topic 6: National Income

[Link] service sector – services to such professions that directly or not indirectly serve the customers.
These are also valued at the market rates.
c. Foreign transactions sector – have the value of goods imported is subtracted from that of goods exported,
while claim of foreign is deducted from the balance created abroad by nations.
[Link] method- Involves aggregating the annual flow of factor carvings generated by the production of
final output; that is, rent earned from land, wage and salaries from employees, profit generated by
entrepreneurs and interest earned on capital.

Thus; NI = NI=n l=r (R1+w1+I1+P1)

Where: R- rent, W – Wage, I – interest, P- profit, I- commodity

[Link] method – Involve aggregating the flow of total expenditure incurred by all the sectors of the
economy on final goods and services. These sectors are domestic, house, domestic producer, the
government and foreign trade.
NI = En + Eb + Eg +Ef
Where: n – individual/ domestic households
b-business/domestic producer
f- foreign trade

Challenges in the calculation of national income

[Link] figure can be collected only from the organized sectors, which are small in size compared to
the large disorganized sector in developing countries.
[Link] figure made available may be faulty.
[Link] counting – the value of products may be included more than once.
[Link] to consider all those production activities which tend to be directed towards barter exchange.
[Link] services may not be included because they cannot be measured in terms of money.
[Link] there is a provision for depreciation, there is no provision for any appreciation that takes place
in the value of stock.
[Link] and currency devaluation create problems.

Uses of national income statistics

[Link] policy formulation – they provide appropriate information that can be used in formation of
economic policies.
[Link] – facilitate the preparation of the annual county and national government budgets.
[Link] growth measurement – help determine whether a country is growing or not.
[Link] of living standards – the per capital income figure derived from not national income
facilitates comparison of living standards in different countries.
[Link] understanding of problems facing countries, such as inflation and unemployment.
[Link] of information on various sectors in an economy. This may be useful for instance investors in
making choice on the sector in to invest.
Thus information on income distribution is an indispensable supplement to national income figure.

Compiled by CPA Nyamanya +254 700 693 826: enyamanya@[Link] Page 5 of 9

 DBM 614: Economics Topic 6: National Income

Limitations of using per capital income in comparing the living standards of people in different
countries.
[Link] of data – Some countries deliberating falsify published national income statistics making
them misleading.
[Link] income distribution within countries – Into account the differing income distributions within
countries. A small group of extremely wealthy citizens might seriously inflate the per capital income
figure of a country with a small population, despite the fact that the great majority of its inhabitants live
in object poverty.
[Link] conversion – Typically currencies are converted into us dollars for the purpose of national
income studies where :
a. Exchange rates do not accurately reflect the relative purchasing power of currencies ( e.g where one
country uses a fixed exchange rate system)
[Link] a small proportion of output is trended internationally, since the price of non- traded goods and
services will have no effect on the level of exchange rates.
[Link] ignores the fact that consumption patterns vary between nations due to wide range of social, cultural,
religious and climatic factors.
[Link] also does not account for non – monetary aspects of living standards, such as the quality of the
environment and of available leisure facilities.
[Link] income countries typically have a very large non – market substance sector, which is often omitted
from, or not fully accounted for in the statistics. Thus comparisons of per capital income figures might
significantly overestimate income differentials between more developed and less developed nations.

The circular flow of income

Is a representation of how income flows through the various sectors of an economy. There are two types of
economies namely:
a. Closed economy – consisting of only consumer/households and producer/ firms.
[Link] economy – consists of both domestic and foreign households and firms.

Circular flow income in a closed economy

Assumptions
[Link] there are only two sectors in an economy namely households and firms.
[Link] households spend all their income on goods and service produced by the firms.
[Link] firm spends all their revenue on factors of production provided by the households.
[Link] there is no government intervention for example in form of taxation or subsidies
[Link] there is no foreign trade in terms of imports and exports.

Compiled by CPA Nyamanya +254 700 693 826: enyamanya@[Link] Page 6 of 9

 DBM 614: Economics Topic 6: National Income

Household’s supply producers with factors of production namely land, labour and capita, and the producers
pay the factor prices in form of rent, wage, interest and profit. Producers as well supply (final) goods and
services to the household, which in turn pay the prices of such goods and services.

Circular flow of income in an open economy

In an open economy, there are domestic producers and households as well as injection and withdrawals.
a. Injection – are factors that increase income and expenditure in an economy. They include:
 Government spending – involving the government buying goods and services from firms or
paying wages and salaries to the households.
 Investment – refers to addition of stock of stock of capital goods into the economy, it leads to
higher income to households as firms utilize more factors to increase production.
 Exports – is the selling of domestic goods in foreign market. It leads to additional income to the
local economy.

Compiled by CPA Nyamanya +254 700 693 826: enyamanya@[Link] Page 7 of 9

 DBM 614: Economics Topic 6: National Income

[Link]/leakages – are factors that decrease (the flow of) income and expenditure in an economy.
They include:
 Taxation – reduces the disposable income of individuals and firms.
 Savings – it’s part of income that is not consumed but kept aside for future use. Savings by
households reduce income received by firms since they have been withdrawn from the circular flow. This
implies that the firms will have enough funds to pay for factors of production.
 Imports – is the buying of foreign gods into the domestic market. It leads to reduction of
income from the local economy.
Domestic households provide factors services to domestic producers. Domestic producers pay prices or
income to domestic households, but before the household receive their income, it is taxed by the
government.
 On receipt of income, the domestic households spends their income in three ways namely:

Compiled by CPA Nyamanya +254 700 693 826: enyamanya@[Link] Page 8 of 9

 DBM 614: Economics Topic 6: National Income

a. Paying for domestic goods and services

[Link] for goods and services from abroad in form of imports
c. Saving to the financial system.
 Financial system may later lend domestic households greater funds for investment.
 The government may spend on current production from domestic producers.
 Thus the total financial spending on domestic production comes from domestic households,
exports, investment and government expenditure while total income generated by domestic households
comes from factor service provided.

Compiled by CPA Nyamanya +254 700 693 826: enyamanya@[Link] Page 9 of 9