CHAPTER 2

Introduction to National Income

Definitions

For production to take place then factors of production need to be employed. These factors of
production are rewarded and this is a source of income to owners of the factors of production.

National income is when incomes of all individuals in a country for a given period are added
together. National income is then the total income received by owners of the factors of
production in a given country over a given period of time usually one year.

National Income is a measure of the total monetary value of the flow of final goods and
services flowing from the productive activities of a nation in one year.

Or

National income it is the monetary value of goods and services produced in a country within a
given period of one year. National Income is a measure of the money value of goods and services
becoming available to a nation from economic activities.

Also,

It can also be defined as the total money value of all final goods and services produced by the
nationals of a country during some specific period of time – usually a year – and to the total of
all incomes earned over the same period of time by the nationals or total income received by the
households in a given year.

Concepts of national income

i. Gross Domestic product (GDP) – refers to the total monetary value of goods and
services produced in a country over a period of one year. GDP deals with all what is
produced within a country’s borders irrespective of who is producing it. This is the total
monetary value of all final goods and services produced within the geographical
boundaries of a country. Why gross? Because, no deduction for the value of the
expenditure goods for replacement purposes (depreciation) is made. The reference to the
word domestic arises from the fact that, only income from investments and possessions

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 in domestic environment are factored and not those from abroad distinguishing it from
Gross national product.
NB The term gross means no deduction for the value of capital consumption
(Depreciation).
ii. Net Domestic product ( NDP) is equal to gross domestic product less depreciation.
iii. Gross national product (GNP) – GNP measures monetary value of goods and services
produced by the individuals of a given country irrespective of whether they are
producing it in their country or outside the country . GNP = GDP + NET FACTOR
Income from abroad (Exports – imports).

NB Net factor income from abroad refers to the difference between the incomes
accruing to domestic residence arising from productive activities abroad less income
earned within the domestic economy accruing to non-residents.

iv. Net national product (NNP): It is the money value of the total volume of production
(that is, the gross national product) after allowance has been made for depreciation
(capital consumption allowance). The concept of NNP provides for capital consumption
(depreciation). Depreciation is the replacement value of capital used in the process of
production. It recognises reduction in value of assets as a result of wear and tear.

NB Net national product = GNP – Depreciation allowance.

v. NNP at factor cost: In measuring NNP, market prices are initially used to value outputs
for aggregation purposes. Since, market prices include indirect taxes and subsidies, the
value of output will not equal the value of the incomes paid to out to FOP. This is so
because revenue received by firms after indirect taxes which is distributed as factor
incomes. Thus, subtracting the income taxes, and adding subsidies from NNP at factor
cost

vi. National disposable income: National disposable income = national income + (-) net
transfer receipts or payments. This concept becomes useful where a country receives
substantial transfers from abroad either to the government or to individual residents, or
alternatively where the residents of a given country send out substantial remittances. This
concept measures the aggregate resources available to a nation for saving or consumption.
vii. Nominal vs. Real national income: nominal national output describes the measurement
of total output in current prices. Price indices are used to convert nominal values, whose
measurement is in the current year prices, to real values by keeping prices at a selected
year base.
Real national income refers to value of total output measured in ‘constant prices’
(measured in the price of a base year).
viii. Per capita Income: this is the national income divided by the total population of the
country. It represents the average income of the people in a given year (i.e. income per

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 head)

Per capita income – it refers to average income per head per year in a given country.
𝑵𝒂𝒕𝒊𝒐𝒏𝒂𝒍 𝒊𝒏𝒄𝒐𝒎𝒆
Per capita income = 𝑻𝒐𝒕𝒂𝒍 𝒑𝒐𝒑𝒖𝒍𝒂𝒕𝒊𝒐𝒏

The Circular Flow of Income

The circular flow model describes the flow of resources, products and incomes among
economic actors. The circular flow diagram helps us understand how an economy works. The
circular flow diagram is a visual model of the economy that illustrates how households and
businesses interact through markets for products and markets for resources.
NB Since firms are involved in production of goods and services then it requires the factors of
production from the households and the firm has to pay for the factors of production. This
payment is an expenditure to the firm but income to households. The households use this
income to pay for the goods and services produced by the firm. In this case this payment is
income to the firm but expenditure to the households.

NB Income keep moving from households to the firm and then back to the households in a kind
of a circle.

The households
- Supply resources (land, labour, capital and entrepreneurial skills) to the resource
markets and receive earnings for those resources
- Demand goods and services from the product markets. make payments for those
goods and services using the incomes they receive
The firms
- Demand resources from the resource markets for production of goods and services
- supply goods and services to the product markets

NB Firms sell the goods and services they produce in product or output markets. The
resources they purchase in order to make their outputs are bought in input (land, labour,
capital, entrepreneurship) or factor markets. These inputs and funds to purchase them are
sourced from households.

An input market is where the resources used to produce goods and services are exchanged. A
labour market is the input market in which households supply work for wages to firms that
demand labour. A capital market is the input market in which households supply their savings
to enable firms to buy capital goods. In exchange they earn interest from the firms who use the
capital goods. A land market is the input market in which households supply land or other real

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property to firms in exchange for rent. In sum each fundamental unit of the economy, whether
household or firm, acts both as producer and consumer.

Forms of the circular flow of income

A. The circular flows of income and expenditure: two sector model

N/B, Households supply factors of production to firms who in exchange provide factor incomes
to households for use of these factors. Firms also provide the households with various types of
goods and services that are consumed by the latter. In turn the firms receive payment for goods
and services they sell to the households. The cycle is complete. The above circular flow can be
illustrated through the factor and product market flow given below

The above circular flow of income is suitable for micro and macro economy

Assumptions in a two sector economy

• There are only two sectors/ players in the economy i.e households and firms
• Households spend all their income on goods and services produced by the firm
• The firm spend all their income on the factors of production provided by the households
• There is no government intervention
• The economy is closed i.e no foreign trade

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 B. Circular Flows of Income and Expenditure in a Five-Sector Model
Apart from households and firms, three other sectors are critical when considering
macroeconomic environment i.e. the government, the external economy, and the financial
institution in the financial system.

As we can see, the flows between the first two sectors, namely households and firms, are
continued. While firms make factor payments to the households, the latter engage in consumer
expenditure and buys goods from firms. Households also invest their surplus savings in
financial institutions (termed as FIs)
These institutions are also known as financial intermediaries since they in turn lend or invest
the household savings they have received in equity and debt securities issued by firms.
Insurance companies, both life and general, form part of the financial institutions sector. They
play a vital role in channelizing surplus funds of households to various productive enterprises.

The third sector in this model is government. It receives its revenues in the form of direct and
indirect taxes, from firms and households. In turn it makes various kinds of factor and transfer
payments to households and also provides funds to firms in the form of subsidies and
purchases.

Finally there is the external or foreign sector. With respect to foreign countries, we have export
of manpower [migration] to foreign countries. These non residents in turn make remittances to
the home country, resulting in precious foreign exchange coming in. Foreign exchange is also
earned when a country exports its goods to foreign countries. On the other hand when a country
imports goods from outside, it has to expend its foreign exchange in paying for these goods.
So long as a country earns more foreign exchange [through exports and inward remittances]
than it needs to pay out [for imports and by way of outward remittances], it can be said to have
a favourable Balance of Payments.

The circular flow of economic activity is a model showing the basic economic relationships
within a market economy. It illustrates the balance between injections and leakages in our
economy. Half of the model includes injections, and half of the model includes leakages. The
circular flow model shows where money goes and what it's exchanged for.

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Injections and withdrawals (leakages)

In reality a two sector economy can not exist. No country can exist without dealing with the
other countries. It is difficult to have an economy where all the income is spend on goods and
services without saving and investments. The firm may spend part of its income to get
machines, factories, office and capital equipment to produce more goods and services. It is hard
to get an economy where government do not take part.
The actions of government savings and investments affect the volume of the income flow
between households and firms. They may increase or decrease the volume of the flow. The
factors that increase income and expenditure in circular flow of income is called injections
while those that reduce the volume of the flow is called withdrawals or leakages

Factors that affect circular flow of income

Savings- it is part of income that is not consumed but is kept aside for future use. Savings
reduce income received by firms. Hence savings are withdrawals/leakages

Government- Government affects circular flow of income by either taxation or expenditure.

(i) Taxation – is a compulsory payment to government. Taxation reduces income available for
spending hence is a leakage

(ii) Government expenditure- the government may buy goods and services from the firms or
pay wages and salaries to households. It may also provide subsidies to firms hence its an
injection
Investments – it refers to additions of the stock of capital goods such as machines, by firms
into their businesses. Capital goods are used to produce other goods and services. Firms borrow
money saved by households in banks or any financial institutions to invest, such investments
leads to higher incomes to households since the capital goods are either hired or bought from
households. The additional income to households is then used to acquire more goods and
services from the firms hence investment is an injection.

Foreign trade – This involves exports and imports. Through exports a country is able to earn
income from other countries. Then exports are injections. On the other hand when a country
import goods and services, it pays foreigners who are outside circular flow of income, then
imports are leakages/ withdrawals.

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NB savings, taxes, imports are withdrawals while investments, government expenditure and
exports are injections.

Summary on Injections and Leakages

Let us now discuss about injections and leakages. When you look at the circular flow model
more closely, you find that there are things that inject money into the economy and other things
that leak out of the economy. Injections into the economy include investment, government
purchases and exports while leakages include savings, taxes and imports.

Savings leaks out to borrowers as it goes through the banking system, and borrowers use the
money to buy goods and services, which then injects the money back into the circular flow.
Government taxes leak out of the circular flow model, and then government spending injects
them back into the economy. Imports leak out of the economy because the money in our
country that's used to buy imports from other countries goes out of our economy and into their
hands. Exports, on the other hand, are an injection because we earn income from the goods
and services we export to other countries.

Production, consumption expenditure and generation of income are the three basic economic
activities of an economy that go on endlessly and are titled as circular flow of income.
Production gives rise to income, income gives rise to demand for goods and services; such a

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demand gives rise to expenditure and expenditure induces for further production. The whole
process forms the basis for circular flow of income and related activities- production, income
and expenditure are known as phases or stages of circular flow of income.
Equilibrium of national income

Equilibrium is a situation where no tendency of change. National income is at equilibrium

when injections are equal to withdrawals.

Total injections = total leakages

S+T+M=I+X+G
Where S is savings

T is taxes

M is imports

I is investments

X is exports

G is government

Significance of the circular flow of income

1. Measurement of National Income - National income is an estimation of aggregation of any
of economic activity of the circular flow. It is either the income of all the factors of production
or the expenditure of various sectors of economy. However, aggregate amount of each of the
activity is identical to each other.
2. Knowledge of Interdependence - Circular flow of income signifies the interdependence of
each of activity upon one another. If there is no consumption, there will be no demand and
expenditure which in fact restricts the amount of production and income.
3. Unending Nature of Economic Activities - It signifies that production, income and
expenditure are of unending nature, therefore, economic activities in an economy can never
come to a halt. National income is also bound to rise in future.
4. Injections and Leakages

Methods in Measuring National Income

Each time a commodity is produced we say that;

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 i. The value of commodity is equal to the purchaser’s expenditure on it
ii. The same sum of money will be received as income by the different individuals who
contributed to the production at the stage
iii. The value of the commodity sold will have resulted from the value added to it by
successive stages of production
Thus, given the above factors, the value of goods and services produced within a certain year
can be calculated theoretically by;
 Adding together market expenditures by final consumers
 Adding income received by various FOP which have contributed to the production and
 Determining the value of each firm’s contribution to output or its value added.
This results to the following methods of determining national income;

i. Income approach to measuring national income (factor income method)

• This takes the sum of money that is received as income by different
individuals who contribute to the production of goods and services. These
incomes may be rent, interest, wages and profit.
• Personal income and public income(the income government receives from
its investments), retained profits (profits set aside to meet the unexpected)
are all included.
• Transfer payments (income earned without there being a corresponding
production of goods and services) are excluded as they represent a re-
distribution of incomes from those who have earned them to the recipients
e.g grants, bursary to students, pocket money e . t. c

• Gross domestic income = personal income + public income + retained

profits + stock appreciation – transfer payments (This national income is
at factor cost as it represent the actual payment).

• In order to get the national income at market price indirect taxes are added
back as they reduce income and subsidies are subtracted as the increase
income.

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 • Gross national income = GDP + X - M

• Net national income = GNI – Depreciation

NB This method takes national income as the sum of all incomes earned by factors of
production in an economy. Included are personal incomes which have been earned for services
rendered and in respect of which there has been some corresponding value of output. Income
as benefits e.g. rent free housing should be imputed as income from employment both in private
and public sectors, the gross trading profits of companies and gross trading surpluses of
public corporations and government, imputed rent (broadly taken to include income from
land or property such as housing) and income from subsistence production
Net property income from abroad is a standard adjustment for all the three methods of
measurement
Adjustments
 Transfer payments e.g. pensions and social security payments are deducted otherwise
double counting would occur. Transfer payments merely represent a redistribution of
income taxpayers’ money to the transfer recipients
 Stock appreciation (Which is the increase in the value of stock as a result of increase
in market prices) is deducted since it has already been adjusted in the output figures.
 Residual error (errors resulting from collection of data); the correcting item is added
to, or deducted from the output and income totals to correct them to the expenditure
totals
 Net factor income from abroad
 Capital consumption or depreciation: This is deducted since new machines and tools
have been produced to replace worn out and obsolete equipment.

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National income statistics for Kenya using the income approach for the period 1997-2000

FACTOR INCOMES 1997 1998 1999 2000

A Non-monetary economy 13,879.80
B Remuneration of employees
Enterprise 146,503.20
Private households 6,174.80
Producers of govt. services 68,989.00
TOTAL 221,667.00
Rental surplus 20,968.64
Other operating surplus 279,748.82
Total monetary economy 522,384.46
Total factor incomes = GDP (@
factor cost)
LESS. Indirect taxes 87,001.51
ADD: Subsidies 30.70
GDP AT MARKET PRICES 435413.65
ADD. Factor income from abroad 1, 350.00
Deduct. Factor incomes paid 14, 973.20
abroad
Gross National Product 421790.45

Thus,
The sum of these incomes gives gross domestic product GDP. This includes incomes earned
by foreigners at home and excludes incomes earned by nationals abroad. Thus, to Gross
Domestic Income we add Net Property Income from abroad. This gives Gross National
Income. From this we deduct depreciation to give Net National Income.

Problems associated with the income approach

• Transfer payments poses a problem since it is difficult to know the proportion of income
that is constituted by transfer payments
NB Transfer payments have to be deducted since they constitute income for which no goods or
services have been produced. A problem arises since it is difficult to input the proportions of
income constituted by these transfers, and especially difficult when the transfers took place and

11
no record was made of them since inclusion leads to double counting.
• The problem of inaccurate data e.g companies do not tell the truth about their income
in order to evade tax. The problem of availability and accuracy of data on income earned,
especially profits of private firms, which may want to evade tax. It is also difficult to
obtain figures for net factor income from abroad.

• Due to price fluctuation it is very difficult to calculate the national income accurately

• The problem of handling illegal and unrecorded economic activities which yield income
to the recipients such as incomes received by drug traffickers and commercial sex
workers

• Imputing income of large subsistence sector in developing countries is difficult given

seasonal and regional price fluctuations. In addition, production or output values for the
subsistence sector in developing countries are difficult to determine

ii. Measurement of national income by product or value added approach (National

output approach)
This is a very direct approach upon which national income is found by adding up the value of all
final goods and services produced by firms during the year. In this, national income is assumed
to be the total of the value added to outputs by all enterprises in the economy. The total or value
added by different stages of production equals the final value of output of a final good.
Value added or net input is the difference between total revenue of a firm, and the cost of raw
materials, services and components. It measures value added to raw materials in production
process. This method totals the value added at each stage of production and then obtains the total
value of all final products.
NB In this approach national income is obtained by adding up the values of all final goods and
services produced by the firms during the year. National income may be obtained by adding all
the values added to the products at each production stage. Total value added at different stages
equals the final value of the output. For example; Firm A produced a commodity and sold it to
B for 250. B sold the product to C at 310 and C sold it to a consumer at 400. The value added
at each stage will be A is 250, C – B = 310 – 250 = 60, Final consumer – C = 400 – 310 = 90)
then total value = 250 + 60 + 90 = 400. The total value is the value of the final product. Only
the value added is counted to avoid double counting

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Adjustments:
 Adjustment for financial services such as insurance and banking include interest paid
to firms lending money. Unfortunately, the interest on borrowed money is also recorded
as a cost to borrowing firms thus double counting
 Stock appreciation: national income statistics is concerned with actual production
added during the year, so an increase in value of stocks due to rising prices is subtracted
 Residual error
 Net factor income from abroad
 Depreciation

This approach therefore centres on final products. Final products will include capital goods as
well as consumer goods since while intermediate goods are used up during the period in
producing other goods; capital goods are not used up (apart from “wear and tear” or depreciation)
during the period and may be thought of as consumer goods “stored up” for future periods.
Final output will include “subsistence output”, which is simply the output produced and
consumed by households themselves. Because subsistence output is not sold in the market,
some assumption has to be made to value them at some price. We also take into account the
final output of government, which provides services such as education, medical care and
general administrative services. However, since state education and other governmental services
are not sold on the market we shall not have market prices at which to value them. The only
obvious means of doing this is to value public services at what it costs the government to supply
them, that is, by the wages bill spent on teachers, doctors, and the like. When calculating the
GDP in this matter it is necessary to avoid double counting.

National income statistics for Kenya using the value added approach at current prices (1997-
2000)
Value added
A. Forestry 1724.20
Fishing 136.6
Building and construction 2492.00
Water collection 1437.80
Ownership of dwellings 8089.20
TOTAL 13,879.80
B. MONETARY ECONOMY
1. Enterprise and non-profit institutions
Agriculture 137,999.00
Forestry 5039.80
Fishing 1688.80

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 Mining and quarrying 815.40
Manufacturing 54,606.92
Electricity and water 18,771
Trade, restaurant and hotels 109,804
Transport, storage and communications 41,816
Finance, insurance and real estate and 68,747.00
business services
Ownership of dwelling 20968.64
Other services 19,973.80
LESS: Imputed bank charges (39,296.20)
TOTAL 445,828.16
Private households (domestic services) 6174.80
Produces of government services 70381.50
Total monetary economy 522,384.46
Total monetary and non-monetary 536,264.26
economy

Problems associated with the value added/ Output approach

• The problem of valuation due to non – availability of inaccuracy of the output figure
especially in the private sector
• The problem of deciding on the goods and services to be included e.g whether the
output of a housewife should be included or not
• Problem of valuing output in the subsistence sector because of inaccurate statistics of
volume of production
• Problem of differentiating primary inputs from intermediate inputs

• Problem of changing prices / different sectional rates of inflation

• The problem of valuing government output since many of its services are not sold in
the market

• Valuing illegal activities like drug trafficking and smuggling (The problem of valuing
illegal activities which might have entered into the production process e.g. drug trade).

iii. Measurement of national income using the expenditure method

Using this approach, national income is achieved by adding together expenditure on all final
goods and services in an economy.
The national income is arrived at by adding all the expenditure on all final goods and services
in the economy. Final goods are the ones that are used by the final consumers (they have
reached their final stage of production) such goods are not used as raw materials in production
of other goods and services.
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 • Total expenditure is broken down as follows
(i) Expenditure on consumer goods by the general public (C) e.g a book bought
by student
(ii) Expenditure on capital goods- capital goods are used to produce other goods
and are also called investments.
NB there are two types of investments

• Fixed capital investments- this refers to the addition of durable goods to the existing
stock of durable goods
• Inventory investment- this is basically the purchase of raw materials as well as goods
for resale. Expenditure on capital goods is denoted as (I)
• Government expenditure which is divided into;

Expenditure on goods and services from households such as hiring of civil servants

Expenditure on goods and services from firms such as buying of office equipment

Expenditure on factor services from households such as hiring civil servants. Government
expenditure is denoted by (G)
• Expenditure on net exports- net exports are total exports less total imports (X- M)

National income = (C + I + G + X – M)

Exports are included as they generate income domestically

Imports are excluded as they do not generate income domestically

NB When using expenditure approach the products are based on market prices because it
involves expenditure on final products there by including indirect taxes and subsidies. The
taxes are subtracted as they increase the prices of the product and subsidies are added back as
they make the product to be cheaper.
• Gross national expenditure (GNE) = C + I + G + X – M + Subsidies – taxes

• Subsidies have the effect of making the final product appear cheaper/less valuable than
true value hence they are added back.

• Taxes are not payment for anything produced and so they are deducted.

• To get the Net National income using expenditure approach then we subtract
(Depreciation)

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 Expenditure = C+G+I+E-M

Adjustments
i. Imports: under both income and output method, imports are excluded, and also in this,
imports are also excluded as they do not generate income domestically
ii. Exports: exports are included as they may create income domestically.
iii. Taxes: taxes are not payment for anything and are therefore not recorded
iv. Subsidies: these make the final product to appear less valuable than it is and so are
added
v. Net factor income from abroad
vi. Less capital consumption
vii. Less the value of physical increase in stocks and work in progress

• National income = C + I + G + X – M + Subsidies – taxes - Depreciation

Illustrating example
Country Y National Expenditure (in £millions) 1999
Expenditure of Consumers
Food 27,148
Alcoholic drink 13,372
Tobacco 6,208
Housing 27,326
Fuel and light 9,395
Clothing 12,114
Household goods and services 12,274
Transport and communications 31,475
Recreation 16,541
Other goods and services 23,356
Total 179,209
Less: Adjustment of non-profit making bodies (443)
178,766
Add: Expenditure of non-profit making bodies 3,661
182,427
Central Government expenditure 40,623
Local Government expenditure 25,236
Capital formation 49,559
Growth in stocks 267

Total Domestic expenditure at market prices 298,112

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 Deduct: Taxes on expenditure (49,865)

248,247
Add: Net result exports-imports 3,186
Subsidies 6,056
Net property income from abroad 1,948 11,190
259,437

Less: Estimated depreciation on capital assets 36,490

TOTAL NATIONAL INCOME 222,947m

Problems associated with the expenditure approach of measuring national income

• It suffers from the problem of double counting
• Differentiating between final expenditure and intermediate expenditure may be difficult
• Fluctuating exchange rates may pose challenges especially in valuation of exports and
imports
 Expenditure for the subsistence sector can only be mere approximations due to lack of
records in this sector ( Imputing the value of spending of the subsistence sector on its
output is difficult)
• No accurate records of expenditure are kept especially the private sector

Problems encountered when measuring national income

a) What goods and services to include
Although the general principle is to take into account only those products which change
hands for money, the application of this principle involves some arbitrary decisions and
distortions. For example, unpaid services such as those performed by a housewife are not
included but the same services if provided by a paid housekeeper would be.
Many farmers regularly consume part of their produce with no money changing hands. An
imputed value is usually assigned to this income. Many durable consumer goods render
services over a period of time. It would be impossible to estimate this value and hence
these goods are included when they are first bought and subsequent services ignored.
Furthermore, there are a number of governmental services such as medical care and
education, which are provided either 'free' or for a small charge. All these provide a service
and are included in the national income at cost. Finally, there are many illegal activities,
which are ordinary business and produce goods and services that are sold on the market
and generate factor incomes.

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b. Danger of Double Counting
The problem of double counting arises because of the inter-relationships between
industries and sectors. Thus we find that the output of one sector is the input of another. If
the values of the outputs of all the sectors were added, some would be added more than
once, giving an erroneously large figure of national income. This may be avoided either
by only including the value of the final product or alternatively by summing the values
added at each stage which will give the same result.
Some incomes such as social security benefits are received without any corresponding
contribution to production. These are transfer payments from the taxpayer to the recipient
and are not included. Taxes and subsidies on goods will distort the true value of goods. To
give the correct figure, the former should not be counted as an increase in national income
for it does not represent any growth in real output.

c. Inadequate Information
The sources from which information is obtained are not designed specifically to enable
national income to be calculated. Income tax returns are likely to err on the side of
understatement. There are also some incomes that have to be estimated. Also, some
income is not recorded, as for example when a joiner, electrician or plumber does a job
in his spare time for a friend or neighbour. Also information on foreign payments or
receipts may not all be recorded.

Uses of national income

• National income statistics refers to all the data collected or computed from various
sources that give information about national income

(i) Indicators of standards of living- standards of living refers to the type of life that a person
or society has according to the amount of money they have. Improvement of income may be
used to mean high standards of living and vice versa
• Comparing standards of living in different countries. The country with high national
income is deemed to have high standards of living. This has drawbacks like;
(i) Different currencies- different countries have different currencies and conversion of
these currencies may be tedious
(ii) Different goods and services- the type of goods and services that are used in
computing national income may differ from one country to another
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(iii) Disparity in distribution of income- although income may be similar the standards of
living may differ due to disparity in income distribution.

(iv) Different taste and needs – Due to different needs and tastes of people living in
different countries, national income statistics may not give a true and fair picture of the
standards of living.

(v) Assessing performance of the economy overtime- By comparing national income in

two different periods the period with higher national income will be considered better.

(vi) Assisting the government to plan the economy - Government may need to compare
performance of different regions or sectors in the country

(vii) Investment decisions- Entrepreneurs may use the national income statistics to
understand the market trends and thereby make appropriate investment decisions. This
is possible because the data from national income statistics may show the sectors which
are growing and which ones are not growing. In this case entrepreneurs invest in the
sectors growing. This saves them time and cost to do market research

Factors influencing the level of national income

• Human resources/ Labour supply – This refers to quantity and quality of workforce
in a country. A country with more people would be expected to produce more than the
country with less people. Similarly a country with more highly skilled labour force
would be expected to produce more and higher quality goods and services than a
country with less skilled labour force. A country is likely to prosper if it has a large
population; literate and numerate sophisticated and knowledgeable about wealth
creating processes. It should be well educated and skilled, with a nice mixture of theory
and practice. It should show enterprise, being inventive, energetic and determined in
the pursuit of a better standard of living.
• Capital – Capital varies from simplest tools to modern equipment's. A country that uses
modern equipment's such as tractors in farming would produce more than the one using
simple tools like Jembes in farming. A nation must create and then conserve capital
resources. This includes not only tools, plant and machinery, factories, mines, domestic
dwellings, schools, colleges, etc, but a widespread infrastructure of roads, railways,
airports and ports. Transport creates the utility of space. It makes remote resources

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 accessible and high-cost goods into low-cost goods by opening up remote areas and
bringing them into production.
• Entrepreneurship – a country which has entrepreneurs who have the ability to
organize other factors of production would have high national income. Where factors
are organized in the correct proportion output is likely to increase hence increasing
national income

• Natural resources/ Land – it includes all natural resources such as forests, water,
minerals, mountains, climate, beaches e . t. c. The size of national income of a country
depends on natural resource endowment that a country have. Then a country with more
resources is likely to have high national income and vice versa. The quality of the
natural resources will also affect the country’s national output.

• Level of technology- the techniques used in production of goods and services

determine not only the quantity but also the quality of goods and services produced.
The higher the level of technology used in the production process the higher the output
and hence high national income

• Political stability- it is a crucial factor that determines size of national income of a

country. The government that maintains a conducive political atmosphere may attract
both local and foreign investors who in turn may contribute to increasing the size of the
national income

• Self-sufficiency
A nation cannot enjoy a large national income if its citizens are not mainly self-
supporting. If the majority of the enterprises are foreign –owned there will be a
withdrawal of wealth in the form of profits or goods transferred to the investing nation.
• Attitude of citizens towards work- a country whose labour force has negative attitude
towards work may register low level of national income compared to another country
where citizens are hardworking.

• Size of subsistence sector- in a country where subsistence sector is large the true level
of national income in such a country may be very low especially where the output is
underestimated. The un marketed output causes a problem

• Foreign investment- increasing foreign investment increases the production of goods

and services there by rising the level of a country’s national incomes. On the other hand

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 reduced foreign investment may lower production of goods and services hence low
national income

Question

• Wages and salaries = 450,000, income from rent = 30,000, profit from corporations =
40,000, Net interest = 80,000’ indirect taxes = 70,000, subsidies = 200,000, depreciation
= 80,000 and net income from abroad = 50,000
Gross domestic product (Gross domestic income) = 450,000+ 30,000+ 40,000 + 80,000
= 600,000

National income at market price = GDP + Taxes – Subsidies

= 600,000 +70,000 – 200,000 = 470,000

Gross national product ( Gross national income) = GDP + Taxes – subsidies + net income
from abroad

= 600,000 + 70,000 – 200,000 + 50,000 = 520,000

Net National income = GNP – Depreciation

= 520,000 – 80,000 = 440,000

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