Undergraduate

BCM1203 :INTRODUCTI
ON TO
MACROECONOMICS

TOPIC 2:NATIONAL INCOME

 Meaning of National Income Undergraduate

• The national income refers to total monetary value of all final goods and services
produced by various firms in an economy within a period of one year. In this case an
economy viewed as one single producer.

• National income consists only of the value of output currently produced hence it
excludes transactions in existing commodities such as existing houses or vehicles.

• But it includes the value of the services of agents that bring buyers and sellers
together to buy these existing commodities.

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National income Concepts Undergraduate

Gross Domestic Product (GDP) – this refers to total monetary value of all final good
and services within the boundaries of a country irrespective of who is producing it.
The term ‘gross’ means that depreciation is included. market value of all final goods
and services produced within a country in a given period of time.

Market Value-GDP uses market prices

All goods-Includes all items produced in the economy and sold legally in markets
(Excludes- Illicit goods, subsistence items)
Final Goods- includes only the value of final goods. The reason is that the value of
intermediate goods is already included in the prices of the final goods.
Produced-Does not include transactions involving items produced in the past.
Within a country-measures the value of production within the geographic confines of a
country
Given period of time-Mostly one year
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National income concepts Undergraduate

• Gross National Product (GNP) – Refers to total monetary value of all goods and
services produced by nationals/citizens of a country irrespective of where they are
producing it

• Thus, GNP=GDP + Net factor incomes from abroad-is the difference between
income accruing to domestic residents arising from activities abroad less income
earned within the country by non-residents

• Net National Product (NNP) = GNP – Depreciation allowance (capital consumption)

• NNP allows for capital consumption which is the replacement value (wear and tear) of
capital used in production process . Note there are difficulties in estimating capital
consumption or depreciation.
• NNP at factor cost - is the actual national income.
• NNP at factor cost = NNP (at Market price) – indirect taxes + subsides
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National income concepts Undergraduate

Gross National Disposable Income(GNDI) – National income +(-) net transfer

payments or receipts. The National disposable income measures aggregate
resources available to nations for saving or consumption (GNI + Net Current
Transfers) . At current prices, the Gross National Disposable Income increased to
KSh 16,997.9 billion in 2024 from KSh 15,752.9 billion in 2023.
Per capita income is the income per head i.e. total national income divided by
population

Nominal National output – measurement of total output in current prices

Real national output is the value of total output measured in constant prices ( base
year prices)
Personal income is the income that households and noncorporate businesses receive.
Disposable personal income is the income that households and noncorporate
businesses have left after satisfying all their obligations to the government

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Importance/ uses of National income statistics Undergraduate

• National income can be used to measure economic welfare or standard of living.

the bigger the national income in a country, the more its citizens will be earning on
average.

• Growth in national income is an economic policy objective of most governments;

Government uses national income for its planning.

• The business community uses national income estimates to plan their

investments.

• National income figures can be used for making international comparisons i.e. to
compare the standard of living of different countries.

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Stock and Flow Variable Undergraduate

Many economic variables measure a quantity of something—a quantity of money, a

quantity of goods, and so on. Economists distinguish between two types of quantity
variables: stocks and flows.

A stock is a quantity measured at a given point in time, whereas a flow is a quantity

measured per unit of time

GDP is the most important flow variable in economics: it tells us how many dollars are
flowing around the economy’s circular flow per unit of time.

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Measuring the Value of Economic Activity: Gross Domestic Undergraduate
Product
Gross domestic product (GDP), is often considered the best measure of how well an
economy is performing.

There are two ways to view this statistic. One way to view GDP is as the total income of
everyone in the economy; another way is as the total expenditure on the economy’s
output of goods and services.

These two quantities are the same: for the economy as a whole, income must equal
expenditure. That fact, in turn, follows from an even more fundamental one: because
every transaction has a buyer and a seller, every dollar of expenditure by a buyer must
become a dollar of income to a seller. When Peter paints Joe’s house for KES 1000,
that KES 1000 is income to Peter and expenditure by Joe. The transaction contributes
KES 1000 to GDP, regardless of whether we are adding up all income or all expenditure

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Income expenditure and the circular flow of Income Undergraduate

• Households buy goods and services from

firms, and firms use their revenue from
sales to pay wages to workers, rent to
landowners, and profit to firm owners.

• GDP equals the total amount spent by

households in the market for goods and
services. It also equals the total wages,
rent, and profit paid by firms in the markets
for the factors of production

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Income expenditure and the circular flow of Income Undergraduate

Flows between firms and households in an economy that produces one good, bread, from
one input, labor.

The inner loop represents the flows of labor

and bread: households sell their labor to firms,
and the firms sell the bread they produce to
households. The outer loop represents the
corresponding flows of dollars: households
pay the firms for the bread, and the firms pay
wages and profit to the households. In this
economy, GDP is both the total expenditure
on bread and the total income from the
production of bread.

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 Approaches to the measurement of National Income Undergraduate

There are three key measures of national income:

i. Product/value added Approach

ii. Expenditure Approach
iii. Income Approach

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National Product or Output Approach Undergraduate

• National product or output is the market value of all final goods and services
produced by all the firms during the year. Found by adding up the values of all
final goods and services produced by firms during a year.

• If we merely added up the market value of all firms’ output, the total obtained would
be in excess of the value of the economy’s actual output. The error that would
arise is called double counting.

• For example, in valuing bread, we do not count the value of the wheat, flour as well
as bread because the values of wheat and flour are included in the value of bread.
• Double counting error is avoided by working with value added.

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 National Product or Output Approach Undergraduate

Example 1
• GDP= sum of value-added
1. Farmers’ value-added
= $2 (Wheat) – 0 (no intermediate goods ) = $2

2. Flour-making factory
= $3.5 (Flour) - $2 (Wheat) = $1.5

3. Bakery Shop
= $6 (Bread) - $3.5 (Flour) = $2.5
GDP=$2+$1.5+$2.5=$6

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National Product or Output Approach Undergraduate

Example 2
The principle of value added is illustrated by a simple example in which there are only
three firms R, I and F. Firm R produces raw materials from scratch valued at Sh.100;
firm R’s value added is Shs.100.
Firm I purchases these raw materials and produces semi-manufactured goods which it
sells for Sh.130. Firm I’s value added is 30.
Firm F works them into a finished state, selling them for Sh.180. Firm F’s value added
is 50/=.The value of the final output is 180/= (instead of 410/= ) is found either by taking
the sales of firm F or by taking the sum of the values added by each of the firms as
follows:

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National Product or Output Approach Undergraduate

Example 2

Firm Value of Intermediate Value added

Output purchase

R 100 0 100
F 130 100 30
I 180 130 50
Total 180

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National Product or Output Approach Undergraduate

• Wheat and flour are called intermediate goods. It is difficult to distinguish between
intermediate goods and final goods
• Double counting error is avoided by working with value added.

• Value added is the value of a firm’s production minus the value of intermediate
purchases from other firms.

• Final goods and services are goods that are sold to the final consumers

• The sum of all values added in an economy is a measure of the economy’s total
output. It is called gross domestic product (GDP).
• GDP using value added method is valued at factor cost

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 Undergraduate
National Product or Output Approach

• Value added by different sectors:

• Agriculture xxx
• Manufacturing xxx
• Transport and communication xxx
• Public, administration and defense xxx
• Education admin & health xxx
• Other services xxx
• GDP at factor cost xxx

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Kenya’s GDP: National Output Method (Source ; KNBS 2025 Economic Undergraduate
survey 2025- Page 43

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Kenya’s GDP: National Output Method (Source ; KNBS 2025 Economic
survey 2025- Page 35-37 Undergraduate

NATIONAL INCOME | AUGUST –NOVEMBER 2025

Kenya’s GDP: National Output Method (Source ; KNBS 2025 Economic
survey 2025- Page 35-37 Undergraduate

NATIONAL INCOME | AUGUST –NOVEMBER 2025

Kenya’s GDP: National Output Method (Source ; KNBS 2025 Economic
survey 2025- Page 40 Undergraduate
ACTIVE LEARNING Undergraduate

• Identify the four greatest contributors to Kenya’s GDP (KES 16.2 Trillion)
• How do we increase contribution of Transport sector to 15%

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Problems associated with Product/output approach Undergraduate

• Problem of product boundary – what goods and services to include exclude, for
example whether to include housewives services and other employment output
values
• Problem of valuation of subsistence goods because of inaccurate statistics of
volume of production and decision on what prices to use considering seasonal and
regional price vitiations
• Rates of inflation. Inflates the figure
• Problem of valuation of government output e.g., education, health. There are no
indicative market prices for such services
• Valuation of illegal activities which might be entered into the production process for
example drugs.

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ACTIVE LEARNING Undergraduate

THE DATA OF MACROECONOMICS| AUGUST –NOVEMBER 2024

National expenditure Approach Undergraduate

This is calculated by adding up all the expenditure on the final output produced in
that year.
Components of GDP
Total expenditure on final output is the sum of four broad categories of expenditure:
consumption (C investment (I) government (G) and net exports (= exports minus
imports i.e. X-M).
Consumption Expenditure (C): includes expenditure on all goods and services
produced and sold to their final users (households) during the year.

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 National Expenditure components Undergraduate

Investment Expenditure:

Refers to expenditure by firms on production of goods not for present consumption.

Investment Expenditure is divided into three categories namely:
i) expenditure on capital equipment and buildings;
ii) construction of residential houses and
iii) stocks of goods currently held by firms for future production or for sale (raw materials
or finished products).

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 National expenditure components
Undergraduate

The total investment expenditure is called gross investment or gross capital formation.
Net investment is Gross investment minus depreciation (capital consumption
allowance).

Government Expenditure: refers to the purchases of goods and services by all levels
of government.
It includes the cost of providing national defense, law and order, street lighting, refuse
collection, health care, education and services of judges e.t.c.

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National expenditure components Undergraduate

Exports (X) : Refers to all goods and services that are domestically produced but sold abroad.
Exports are not included as part of C, I, or G since they are not purchased by the domestic
residents.
Imports (M) : Imports are the goods that are produced abroad but purchased for use in the
domestic economy by households, firms and government.

Net Exports (X-M). Net exports are defined as the value of total exports of goods and services
minus the value total imports of goods and services (X – M)

• When the value of exports exceed the value of imports, the net export term will be
positive.
• When the value of imports exceed exports, the value of net export term will be
negative.

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Expenditures not included in GDP Undergraduate

Only final expenditures are included.

The following items are not part of final expenditures:
i. Intermediate goods or producer goods or semi-finished products – These are
partly finished goods which may be used as inputs for production of other goods
including final goods.
ii. Second-hand goods: expenditure on second hand goods is not part of GDP
because these goods were counted in the period in which they were produced.

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Expenditures not included in GDP Undergraduate

iii. Financial securities: firms often sell financial securities such as bonds and stocks to
finance purchase of newly produced capital goods e.g EABL. They are not included
because they are financial transactions, not services produced .
iv. Transfer payments such as payments to old age pensioners, unemployment
benefits welfare e.t.c. are excluded because the government receives no goods or
services in exchange.
Thus GDP expenditure based is the sum of consumption, investment, government and
net exports expenditure on currently produced goods and services.

GDP = C + I + G + ( X – M)

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Expenditure approach: Exclusion, Inclusion list Undergraduate

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Expenditure approach Undergraduate

In summary;
GDP = C + I + G + ( X – M)
Expenditure categories
Consumption(C) xxx
Government expenditure(G) xxx
Gross investment (I) xxx
Exports(X) xxx
Imports(M) (xxx)
GDP at market prices xxx

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Kenya’s GDP: Expenditure Approach Method. KNBS 2025
Economic Survey Undergraduate

¹ Non Profit Institutions Serving Households ² Difference between GDP

production approach and GDP expenditure approach
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Problems associated with Expenditure approach Undergraduate

• No accurate records are kept, especially in the private sector

• Imputing or estimating the value of the subsistence sector on the output is difficult
• Distinguishing between expenditure on final goods and intermediate goods
• Double counting on: student allowance, bursaries, interest on public debt, second
hand cloth goods, financial assets neither which involve fresh out put.
• The problem of valuation of imports and exports in the economy- caused by
fluctuating exchange rates

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National Income approach Undergraduate

Found by adding together all incomes paid by firms to households for the services of
factors of production they hire i.e. by adding wages, interest rent for land and
profits together.
Divided into the following categories:
Income from employment which consists of wages and salaries (normally referred
to as wages).
Income from self employment that covers those people who are earning a living
by selling their services or output but who are not employed any one organization.

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National income approach Undergraduate

Rent. Rent is the payment for the services of land and other factors that are rented.

Profits. Profits are net business incomes after payment has been made to hired
labour and for material inputs. Profits are divided into distributed (dividends) and
undistributed profits (called retained earnings).

Interest . The net interest category includes interest payments by domestic

businesses and the rest of the world to households and firms who have lent to them

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National income approach Undergraduate

In Summary;
Components of GDP by income type
Income from employment (Salaries and wages) xxx
Income from self employment xxx
Gross profits xxx
Rent xxx
Interest xxx
GDP at factor cost xxx

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National income approach Undergraduate

Example

• Firm 1 produces steel, employing workers and using machines to produce the
steel. It sells the steel for $100 to Firm 2, which produces cars. Firm 1 pays its
workers $80, leaving $20 in profit to the firm.

• Firm 2 buys the steel and uses it, together with workers and machines, to produce
cars. Revenues from car sales are $200. Of the $200, $100 goes to pay for steel
and $70 goes to workers in the firm, leaving $30 in profit to the firm.

• Calculate GDP using income approach

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 National income approach Undergraduate

Example

Of the $100 of value added by the steel manufacturer, $80 goes to workers (labor
income) and the remaining $20 goes to the firm (capital income).

• Of the $100 of value added by the car manufacturer, $70 goes to labor income and
$30 to capital income.

• For the economy as a whole:

– labor income is equal to $150 ($80 + $70),
– capital income is equal to $50 ($20 + $30).
– Value added is equal to the sum of labor income and capital income is equal to $200
($150 + $50)

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Problems associated with income approach Undergraduate

• Problem with imputing Transfer payment especially when there are no records. Not
all transfer payments are officially recorded.

• Unavailability of accurate data on income earned – profits from private firms which
may want to evade tax.

• Estimating the value of the subsistence sector

• Problem of valuation of illegal activities which might be entered into the production
process for example drugs

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Important Adjustments when Estimating National income Undergraduate

1. From factor cost to market price

The sum of all the final expenditures on goods and services gives us GDP at market
price.
But income approach gives GDP at factor cost obtained by adding together the
incomes paid to the factors of production used to produce those goods and services.
The presence of government (that subsidizes and taxes production) means that that
the two methods of valuation will give two different values of GDP.

i. Taxes levied on transactions on goods and services are known as indirect

taxes. The effect of an indirect tax is to make the market price of a product
greater than the sum received by the factors of production.
ii. Subsidies: The existence of a subsidy means that the market price may be
less than the total reward to factors.

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Adjustments
Undergraduate

From GDP at factor cost to GDP at market prices

• Thus GDP at factor cost XXX
• Add Indirect taxes XXX
• Less Subsidies (XXX)
• GDP at market prices XXX

From GDP at market prices to GDP at factor cost

While to GDP at market price XXX
Less Indirect taxes (XXX)
Add Subsidies XXX
GDP at factor cost XXX

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 Undergraduate
Adjustments

iii. Net Factor Income from Abroad

GDP at market prices measures total output produced in the economy and total
income generated as a result of that production.

However, some of the output produced within the country is produced by firms are
owned by non residents while some output produced outside the country is actually
produced by firms owned by domestic residents abroad. Output produced by
Volkswagen(VW) in Kenya counts towards our GDP but some of the profits made by
VW here are sent back to Germany – adding to their GNP

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 Undergraduate
Adjustments

Net property or Net factor income is income received by domestic residents from
assets owned abroad minus income paid out to non resident who own assets in the
domestic economy.
Thus Gross Domestic Product (GDP) + Net property/ NFIA = Gross
National Product
Gross National Product (GNP): the market value of all final goods and services
currently produced in the economy.

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Adjustments Undergraduate

iv. Depreciation refers to the value of wear and tear on the existing capital stock.
For example houses depreciate over the course of time, while machines wear out as
they are used.

Depreciation (or capital consumption allowance) is measure of the part of GDP or

GNP that has to be set aside to maintain the productive capacity of the economy.

When we subtract depreciation from GDP we get Net Domestic Product and when
we subtract depreciation from GNP we get Net National Product (NNP).

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Reconciling GDP with GNP from Expenditure based Undergraduate

Consumption xxx
Government expenditure xxx
Investment expenditure xxx
Net exports xxx
GDP at market prices xxx
Less: indirect taxes (xxx)
Add: Subsidies xxx
GDP at factor cost xxx
Add Net factor income from abroad xxx
GNP at factor cost xxx
Less Depreciation (xxx)
Net National income (NNP at factor cost) xxxx

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Other income concepts Undergraduate

Personal income
Is the income that is earned by or paid to individuals before allowing for personal
income taxes on that income.

In the course of the year, some households earn incomes but do not receive all
of it- reinvestment of profits
On the other hand, there are households who receive incomes but do not earn it
during the current production period-pension

Thus, national income is either larger or smaller than personal income.

Thus we add to national income (NI), the income received but not earned and subtract
the income earned but not received, to convert national income into personal income.

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Therefore; Undergraduate

National Income xxx

Add: income received but not earned
Government and business transfer xxx
Net interest paid by government xxx
Less income earned but not received:
Undistributed corporate profits (xxx)
Corporate income taxes (xxx)
Contributions for social insurance (xxx)
Personal income xxx
Less: personal income tax (xxx)
Personal disposable income xxx

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 Undergraduate

Using income approach;

Salaries and wages XXX
Profits XXX
Rents XXX
Interest XXX
GDP at factor cost XXX
Net property income(NFIA) XXX
GNP at factor cost XXX
Less: depreciation (XXX)
National income(NNP) XXX

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ACTIVE LEARNING- See uploaded addendum for question and answer
Undergraduate

In a simple economy, suppose that all income is either compensation of employees or profits. Suppose also
that there are no indirect taxes. Given the information below about income and spending in the economy
Consumption KES 5,000
Investment KES 1,000
Depreciation KES 600
Profits KES 900
Exports KES 500
Compensation of employees KES 5,300
Government purchases KES 1,000
Direct taxes KES 800
Saving KES 1,100
Imports KES 700
Required
Calculate gross domestic product from the following set of numbers. Show that the expenditure
approach and the income approach add up to the same figure

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ACTIVE LEARNING- See uploaded addendum for question and answer
Undergraduate
Aloha is a country known for a buzzing livestock sector. The following National Income statistics relate to Aloha
in Millions of United States Dollar

Consumption $ 3Million
Investment $5 Million
Depreciation $9Million
Exports $4.5 Million
Compensation of employees $1Million
Government purchases $4.5 Million
Direct taxes $1Million
Saving $3 Million
Imports $6 Million
Population 5000
Net Factor Income from Abroad $10 Million

Calculate
i. Gross Domestic Product (GDP) using Expenditure approach
ii. Gross National Product iii) Net National Product iv) GDP Per Capita

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ACTIVE LEARNING- See uploaded addendum for question and answer
Undergraduate

Given the following National income statistics relating to your Utopia in millions of
local currency.
Disposable Personal Income 56m
Net indirect taxes 7m
Contributions to social security 15m
Personal income taxes 5m
Retained Profits 12m
Corporate taxes 10m
Government transfer payments 5m
Depreciation 3m
Net factor income from abroad -6m

Calculate
i. National income
ii. GDP at market price
iii. GNP at factor cost
iv. Personal Income

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In conclusion; Undergraduate

Assuming that all the three measures are calculated accurately, then it must
follow that all the three measures will provide an identical figure for the value of
country’s total output.
GDP measures both the total income and total expenditure on the economy’s
output of goods and services. For an economy as a whole, income must equal
expenditure Y=E.
An economy’s income is equal to expenditure because every dollar of spending
by some buyer is a dollar of income for some seller. So GDP rises by $1
whether measured through income or expenditure approach

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Recall: Circular flow of income model Undergraduate

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Assumptions of circular flow of income Undergraduate

1. There are only two players/sectors i.e. households and firm

2. The household spend all their income received on the purchase of goods and
services i.e. no saving
3. The firms spend all their incomes on payment of factors of production provided by
the households
4. There is no government intervention
5. The economy is closed i.e. no foreign trade

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Factors affecting the flow of income Undergraduate

The factors that increase the income and expenditure are referred to as injections
while those that reduce the flow are referred to withdrawals/leakages.
• Savings- this is the part of income that is not consumed but kept aside for future
use. Savings by households reduce income received by the firms since they are
withdrawn from the circular flow. This implies that the firms will not have enough
funds to pay for the factors of production. Savings are therefore withdrawal

• Investment- this addition to the stock of capital into the economy. Firms may make
use of the funds that households have saved in financial institutions to invest. This
lead to higher incomes to the households as firms utilizes more factors to increase
production. Investments are therefore injections

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 Factors affecting the flow of income Undergraduate

Foreign trade
Export earns a country foreign income which is an addition to the income flow hence
they are injections.
Countries pay to foreigners for imported goods and services thus they constitute
leakages.

Government- the government can affect the flow either by taxation or government
expenditure

Taxation- it reduces the amount available for spending hence it’s a leakage or
withdrawal from the circular flow.
Government expenditure- government can buy goods and services from firms or pay
wages and salaries to the households hence constituting the injections

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Factors affecting flow of income Undergraduate

Government expenditure- government can buy goods and services from firms or
pay wages and salaries to the households hence constituting the injections

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Factors that Influence the Size of a Country’s National Income Undergraduate

1. The nature and size of natural resources (e.g. mineral deposits, fertility of the soil)
2. The nature of the labour force (e.g. in relation to the total population, its energy,
skills and ability).
3. The amount of capital investment. Some countries attract capital investment more
easily than others.

4. The efficiency with which the factors of production like land, labour and capital are
combined.
5. The ability of the country to produce innovative ideas (e.g. new technologies)
6. Political stability.

7. The availability of foreign loans.

8. The terms of trade (i.e. the amount of goods and services of another country which
can be obtained for specific quantity of home produced goods and services.
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Effect of elections on GDP: Source: Institute of Economic Affairs Undergraduate

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Kenya’s Annual GDP growth rate 1961-2024 Undergraduate

[Link]

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ACTIVE LEARNING: Undergraduate

Other emerging factors that influence national income in Sub-Saharan Africa states?

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Real and Nominal output (GDP) Undergraduate

• The total money value of national output is often called nominal national income.
• Changes in nominal or money (GDP) can be brought about by a change in
either the (i)physical quantities (amount) of goods and services produced or the
(ii)prices on which the output is based.
• On the other hand real GDP refers to GDP valued at a common set of base –
period prices.
• Thus when real income is measured over different periods using a common set
of base – period prices, changes in real income only reflect changes in real
output (amount of goods and services).

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Real and Nominal output (GDP) Undergraduate

• When we add up money values of outputs, expenditure or incomes, we get

nominal GDP.
• Nominal GDP measures GDP at the prices currently prevailing when those goods
and services are produced (i.e. GDP at current year prices).
• If in successive years the economy produces the same physical quantities of
output but all prices are 10% higher say in the second year, the nominal GDP in
the second year will be 10% higher than in the first year.

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Real and Nominal output (GDP) Undergraduate

• Nominal GDP measures the current dollar value of the output of the economy
• Real GDP measures output valued at constant prices.
• Real GDP adjust for inflation by measuring GDP in different years at prices
prevailing at some particular calendar date (year) known as the base year.
• The table below presents a simple hypothetical example of the whole economy.

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ACTIVE LEARNING
Undergraduate

X Y Nominal Output Real Output GDP Deflator

P Q P Q Current Price*Q Base price*Q Nominal/Rea

1975 2 100 4 100 2*100+4*100=600 2*100+4*100= 600/600*100

600 =100%

1987 4 150 6 140 4*150+6*140=1440 2*150+4*140= 1440/860*100

860 =167%

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Real and Nominal output (GDP)
Undergraduate
The GDP Deflator Undergraduate

• Nominal GDP increases from 600 to 1440. An increase of 840

• If we take 1975 as the base year we can measure the real GDP which increased
from 600 to 860. An increase of 260,

• For 1975( Base Year) Nominal and real GDP coincide. Their ratio is 1 and the value
of the index is 100.

• For 1987, the ratio of nominal to real GDP = 1.674 (1440/860) and the index is
1.674 x 100 =167.4. According to the GDP deflator, prices for the economy as a
whole increased from 100 % to 167.4 % an increase of 67.4% between 1975 and
1987.
• Price index is used to measure changes in the price level by comparing the
price of a basket of goods and services in the current year to the price of this
basket in the selected base year.

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The GDP Deflator/ implicit price deflator for GDP Undergraduate

The GDP deflator is the ratio of nominal GDP to real GDP expressed as
an index. Expressing the deflator as an index means that the ratio of
nominal to real GDP is multiplied by 100.

(i)GDP Deflator =Nominal GDP/Real GDP

The GDP deflator measures the price of output relative to its price in the base year
(ii) Nominal GDP = Real GDP *GDP Deflator.

(ii)Real GDP =Nominal GDP/ GDP Deflator

In this form, you can see how the deflator earns its name: it is used to deflate
(that is, take inflation out of) nominal GDP to yield real GDP

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ACTIVE LEARNING Undergraduate

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GDP Rebasing Undergraduate

• Rebasing is the process of replacing an old base year with a new and more recent
base year. A base year provides the reference point upon which future values of the
GDP are compared.
• The base year chosen must be a representative year and must not experience any
abnormal incidents such as droughts, floods, earthquakes, a major economic
downturn etc.

• GDP Rebasing is an exercise undertaken by national statistical offices to ensure that

national accounts statistics present the most accurate reflection of the economy.

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Per Capita Real GNP Undergraduate

• Real GNP gives a simple measure of the physical output of an

economy and the annual percentage increase gives us an idea of
how fast the economy is growing.
• Per capita real GNP is real GNP divided by the total population. It
is real GNP per head.
• It gives us an idea of quantities of goods and services available for
an average citizen.
• For a given level of real GNP, the larger the population, the smaller
will be the quantities of goods and services available to each
individual.
[Link]

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Per Capita Real GNP Undergraduate

To do this we have to convert national income to real national income per head.
i) First national income must be converted to real national income by deflating by an
appropriate price index.
ii) the figure is then divided by the total population to convert it to per capita terms.

GDP Per Capita= GDP/ Population

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Per Capita Real GNP
Undergraduate

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GDP Per capita Undergraduate

[Link]

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GNI Per capita Bands by World Bank for the current 2025 Undergraduate

fiscal year

Low-income economies : $1,145 or less

Lower middle-income economies : $1,146 -$4,515

Upper middle-income economies : $4,516- $14,005

High-income economies More than : $14,005.

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ACTIVE LEARNING
Undergraduate

[Link]
level-for-2024-2025

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 ACTIVE LEARNING Undergraduate

How do we improve national income of Sub- Saharan Africa States?

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Why would policy makers care about GDP Undergraduate

• Having a large GDP enables a country to afford better schools, a cleaner environment,
health care, etc.

• Many indicators of the quality of life are positively correlated with GDP. For example??

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GDP and the quality of life Undergraduate

[Link]
[Link]

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GDP and Happiness: Can Money buy happiness? Undergraduate

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Why would policy makers care about GDP Undergraduate

Gross Domestic Product…

“… does not allow for the health of our children, the quality
of their education, or the joy of their play. It does not
include the beauty of our poetry or the strength of our
marriages, the intelligence of our public debate or the
integrity of our public officials.
It measures neither our courage, nor our wisdom,
nor our devotion to our country. It measures everything,
in short, except that which makes life worthwhile, and it
can tell us everything about America except why we are
proud that we are Americans.”

- Senator Robert Kennedy, 1968

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Problems encountered when measuring national income
Undergraduate

1. Unreported activities: The transactions that occur in the underground

economy/black economy are perfectly legal in themselves but are not reported for tax
purposes hence are omitted in the GDP. For example a carpenter could repair a leak
in a neighbor’s roof and take home payment in cash or in kind.

2. Non-marketed activities: These are activities which owners do themselves and

hence do not pass through the markets. They include all forms of household chores
that people do by themselves.

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 Undergraduate

Problems encountered when measuring national income

3. Economic ‘bads’/Harmful Side Effects : Economic ‘bads’ such as pollution,

congestion and the destruction of the natural environment that accompany
production are not included in the GDP but the values of the goods and services are.

4. Illegal activities such as illegal gambling, drug trade are not included in GDP
even though many of them are business activities that produce goods and services
sold on the market and that generate factor incomes. The fact that they are
excluded means that GDP underestimates the value of a county’s output

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 Problems encountered when measuring national income Undergraduate

5. Depreciation: GNP does not take depreciation into account .To make this
adjustment, depreciation must be deducted from GNP in order to obtain the NNP.
However depreciation is not easy to measure and hence NNP estimates contain
whatever errors made in estimating depreciation.

6. Lack of appropriate unit of measurement: The problem is partially overcome by

using money as the unit of measurement. However, the value of money itself
changes over time.

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ACTIVE LEARNING Undergraduate

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WORLD’S LARGEST ECONOMIES Undergraduate

[Link]

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Limitations of using per capita income to measure Undergraduate
standards of living

Even if real income per capita rises, it does not necessarily mean that actual economic
welfare have improved because of the following reasons.

1. Income Distribution: GNP per capita does not tell us how the output is distributed
among the [Link]://[Link]/statistics/264627/ranking-of-the-20-
countries-with-the-biggest-inequality-in-income-distribution/
2. Social Costs: GNP does not reflect the social costs arising from the production of
goods and services. For example, environmental damage, pollution and congestion
not reflected in the GNP estimates hence it overestimates the value of a country’s
output.
3.) Gainers and Losers: Increases in real output per capita occasioned by
technological progress/ advancement often leave some people worse off and others
better off.
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Inequality
Undergraduate

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Limitations of using per capita income to measure Undergraduate

standards of living

4. Income in relation to effort: An increase in real output per capita may not even
increase economic welfare if it is accompanied by increased number of hours of
work and inferior working conditions.
5. Quality Changes: GNP does not take adequate account of changes in the
quality of goods and services unless those changes are reflected in the prices of
those goods.
6. Composition of goods: GNP does not show the composition of goods and
services. For example, a rise in real income per capita may be caused by an
expansion of capital goods and public sector expenditure on civil service and
defense which do not increase current economic welfare.

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Limitations of using national income figures to compare Undergraduate

standards of living in different countries

1) To use real per capita income to compare the standard of living of different
countries, we have to convert them into a common currency using the exchange rate.
However the market rate of exchange may not measure the relative amounts of the
goods and services consumed in each countries – distortions due of exchange rates.

2)Different countries have got different tastes and needs which may not be taken into
account in making comparisons. For example, the need for commuting or heating in
extremely cold areas will differ between countries.

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Limitations of using national income figures to compare Undergraduate

standards of living in different countries

3) Real income per capita does not show the distribution of income. For example, a
country with a lower income per capita but more evenly distributed income may have a
higher standard of living than another with a higher income per capita but unevenly
distributed income.

4) Government expenditure; government expenditure forms a major component of the

GDP. Differences in expenditure by governments in different countries will make
comparison different.

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Limitations of using national income figures to compare Undergraduate

standards of living in different countries

5) Variations in the length of the working week: between different countries. For
example, per capita income may be higher in country A than country B but if the
average working week is higher in country A than in B, then we can not say that the
standard of living is higher in country A than in B.

6) Non Monetary transactions: National income accounts measure monetary

transactions hence omits non monetary transactions which are however
economically beneficial. Thus it is difficult to compare the standard of living
between two countries if one has a substantial amount of subsistence production
while the other an insignificant subsistence production.

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Limitations of using national income figures to compare Undergraduate

standards of living in different countries

7) Differing Composition of the final output; Composition of the final output may differ
between countries. For example one country may have a higher per capita income
but a large amount of capital goods or military goods than another country which
may have a large amount of consumer goods and a small amount of capital goods
and/or military goods.

[Link]

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 Undergraduate

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