NATIONAL INCOME
- This is the total income received by the providers/owners of the factors of production in a given country over a specific time period.
Terms used in national income
- Gross Domestic Product (GDP): This is the total monetary value of all goods and services produced within a country during a particular year. Such goods and services must have been produced within the country.
- Net Domestic Product (NDP): This is the GDP less depreciation. Depreciation is the loss in value of assets such as machines used in the production of goods and services.
- Gross National Product (GNP): This measures the total monetary value of all goods and services produced by the people of a country regardless of whether they are inside or outside the country. It takes into account exports and imports. The difference between exports and imports is called net Factor Income from abroad. GNP is therefore the sum of GDP and net factor income from abroad.
- Net National Product (NNP): This recognizes the loss in value of the capital used in the production of goods. Capital here refers to capital goods. NNP is the difference between GNP and depreciation.
- Per capita income: This is the average income per head per year in a given country. It is also the national income divided by the population of the country.
CIRCULAR FLOW OF INCOME
- This is the continuous movement of income between households (providers of factors of production) and firms (producers of goods and services).
- The factors of production are provided by households.
- Firms pay rewards for such factors to households (expenditure to firms and income to households).
- Households use the income to buy goods and services produced by firms (expenditure to households and income to firms).
Assumptions/features of circular flow of income
- Existence of two sectors only: It is assumed that the economy has only two sectors, households and firms. Households provide the factors of production, while firms produce goods and services.
- Total spending by households: Households are assumed to spend all their income on goods and services produced by firms, i.e., no savings.
- Total spending by firms: Firms are assumed to spend all money received from sales to pay for the rewards of production factors.
- Lack of government intervention: The government does not influence how firms and households carry out their activities. Such interventions include taxes, price controls, among others.
- Closed economy: Exports and imports do not exist in such an economy.
Factors affecting the circular flow of income
- The factors can either lead to an increase in income and expenditure (injections) or reduce the volume of flow (withdrawals).
The factors include the following:
- Savings: Occurs when households do not spend all their income on goods and services. This reduces income received by firms; hence, savings is a withdrawal from the circular flow of income.
- Taxation: Reduces the amount of money available for spending; therefore, it is a withdrawal/leakage from the circular flow of income.
- Government expenditure: When the government buys goods from firms or provides subsidies, this translates into an injection into the circular flow of income.
- Investments: When firms invest more capital into production, output increases, leading to an increase in income (injection).
- Imports: When goods and services are bought from other countries, money is spent abroad, reducing the circular flow of income (withdrawal).
- Exports: Through exports, a country receives money from other countries (injections).
Injections
- Investments
- Government spending
- Exports
Withdrawals
- Savings
- Taxation
- Imports
APPROACHES USED IN MEASURING NATIONAL INCOME
- Expenditure Approach
National income is calculated by summing expenditure on all final goods and services (those that have reached the final stage of production). Such expenditure is divided into:
- Expenditure on consumer goods (C)
- Expenditure on capital goods (I)
- Expenditure by government (G)
- Expenditure on net exports (X – M)
Therefore, national income = C + I + G + (X – M)
Problems associated with the expenditure approach
- Lack of accurate records, particularly in the private sector.
- Approximation of expenditure in the subsistence sector.
- Difficulty in differentiating between final expenditure and intermediate expenditure.
- Double counting may occur.
- Fluctuating exchange rates may cause problems in valuing imports and exports.
- Income Approach
- This method calculates national income by summing all money received by those who participate in producing goods and services.
- Such incomes are rewards to the production factors (wages, rent, interest, and profits).
- Public income is also included, i.e., income received by the government from its investments (Parastatals, joint ventures).
- Transfer payments are excluded since they represent redistribution of income from earners to recipients, e.g.,
- National insurance schemes.
Problems related to this method
- Determining what proportion of transfer payments constitute national income.
- Inaccurate data may exist as business people may underreport income to evade tax.
- Price fluctuations may complicate national income determination.
- Income from illegal activities is not captured.
- Valuing income from the subsistence economy may be difficult, e.g., housewives.
Assignment: Read and make short notes on Output approach (refer to Inventor book three pages 65–66).
USES OF NATIONAL INCOME STATISTICS
- Indicators of standards of living: If national income is equitably distributed, standards of living will be high.
- Measuring economic growth: Statistics of one year are compared with previous years to show improvement or decline.
- Inter-country comparison: Used to compare economic welfare among countries, indicating which country is better off and by how much. Challenges include differences in currencies, goods and services, income distribution disparities, and differences in tastes and preferences.
- Investment decisions: Assist government and investors in identifying sectors to invest in by providing performance information.
- Basis of equitable distribution of income: Can be used to spread income among the majority if a few individuals control the economy.
- Planning purposes: Shows contribution of each sector, helping government allocate funds effectively.
Factors which influence the level of national income
- Quantity and quality of production: More and better-quality factors lead to higher output and national income.
- State of technology: A country with advanced technology produces goods in large volumes, increasing national income.
- Political stability: Politically stable countries experience higher production and national income levels.
- Accuracy of accounting systems: Accurate data collection methods ensure reliable national income statistics.
- Proportion of the subsistence sector: Since subsistence output is often excluded from statistics, a large subsistence sector lowers reported national income levels.
NB. For other factors, refer to Inventor book three pages 68–69.
Reasons why high per capita income is not an indicator of better living standards in a country
- Statistical problems: Inaccurate data collection may lead to incorrect national income figures and wrong per capita income.
- Changes in money value: Currency devaluation can change money value without reflecting changes in people’s welfare.
- Income distribution: High per capita income may be concentrated in few hands, not representing the majority.
- Nature of products: If products do not satisfy immediate wants, increased per capita income may not improve economic welfare.
- People’s hard work and attitude: Increased national income may mean less leisure and more stress, reducing welfare despite income rise.
- Social costs: Migration from rural to urban areas may strain family relationships, and industrial growth may cause pollution and congestion.
Questions
- State four problems encountered in comparing standards of living in different countries using national income statistics.
- Using a diagram, describe the circular flow of income.
- Explain five factors that may influence the level of national income of a country.
- Outline four limitations of the expenditure approach used in measuring national income.
- Explain five reasons why high per capita income may not translate to better living standards in a country.
- Describe five factors that affect the circular flow of income.
