National Income – SS2 Economics Lesson Note (Third Term)

National income is the monetary value of all goods and services a country produces in a year. It is also the money value of the income earned by all factors of production in the country over the period. It is measured by the income, output and expenditure approaches, and is used to judge growth and standard of living.

Behavioural objectives

By the end of the lesson, students should be able to:

• define national income and distinguish it from government income;
• define and calculate GDP, GNP, NDP and NNP;
• explain personal income, disposable income and per capita income;
• describe the income, output and expenditure approaches to measuring national income;
• state the reasons for measuring national income and the problems involved;
• explain standard of living, cost of living and price index.

What is national income?

Individuals and firms keep account of their economic activities, for example in an annual report that shows all their activities during the past year. Countries also record and keep account of their economic activities.

National income can be defined as the monetary value of the total volume of goods and services produced by a country in a year. It is the money value of the total income earned by all the factors of production in a given country over some time, usually a year.

It is also the total of the monetary value of all individual expenditures on goods and services at market prices.

National income is different from the income of the government, which refers to the revenue the government raises through taxation and borrowing.

What are the main concepts of national income?

1. Gross Domestic Product (GDP)

GDP is the total monetary value of all the goods and services produced in a country in a year by all the residents of the country, whether they are citizens or foreigners. It relates to a closed economy, that is, it excludes the earnings or investment of citizens abroad but includes the earnings of foreigners or earnings from foreign investment in the country. It can be measured at factor cost (adding together of production) or at market prices.

In its calculation, no allowance is made for depreciation. So, it is best expressed as the addition of these three aggregates:

GDP = C + I + G

where C = Consumption, I = Investment and G = Government expenditure.

The GDP is used as an economic indicator to determine whether the country is growing, declining or stagnant.

2. Gross National Product (GNP)

GNP is the monetary value of goods and services produced by the citizens of a country, including income from their investments both at home and abroad.

It is the total value of goods and services plus net income from abroad, which can be represented as (x – m), where x = export and m = import.

That is to say, it includes the earnings of the citizens or their investment in other countries but excludes the earnings of foreigners or their investment in the country. Here too, no allowance is made for depreciation.

Mathematically, it is expressed as:

• GNP = GDP + Net income from abroad; or
• GNP = GDP + (x – m); or
• GNP = C + I + G + (x – m)

3. Net Domestic Product (NDP)

NDP is the total monetary value of goods and services produced by all the residents of a country, whether citizens or foreigners, and earnings from their investment, after allowance has been made for depreciation.

Mathematically, it is represented as:

• NDP = GDP – Depreciation; or
• NDP = C + I + G – Depreciation

4. Net National Product (NNP)

NNP is the difference between GNP and the estimated depreciation, or capital consumed during the year. It is the monetary value of goods and services produced by all the citizens of a country and income from their investments (whether at home or abroad) after allowance has been made for depreciation.

• NNP = GNP – Depreciation; or
• NNP = C + I + G + (x – m) – Depreciation

5. Personal income

Personal income is the earnings of an individual in monetary terms for taking part in the production of goods and services, either by himself or through his property. It includes wages to labour for its services, interest received by the capital owner, rent paid to the owner of land, and profit received by an entrepreneur.

6. Disposable income

Disposable income is the income from all sources that accrues to households and private non-profit institutions after deducting personal income tax and other transfers. It is the income available for spending and saving.

It can therefore be summarised as: Disposable income = Personal income – Personal tax.

7. Per Capita Income (PCI)

Per capita income is the national income per head of the population. It is the national income divided by the total population of a country. It is an economic indicator of a country’s standard of living. Whether the PCI of a country is high or low depends mainly on the available resources and the size of the population.

An increase in the GNP of a country does not necessarily mean an increase in PCI.

By formula, PCI = GNP / Total population

How is national income measured?

1. Income approach

In this method, the total monetary value of income received by individuals, business organisations and government agencies within a year for their participation in production is calculated. The income received by factors of production in the form of wages or salaries, rent, interest and profits is added together. To avoid double counting, transfer incomes or payments are not included. This approach gives either the GNP or the GDP at factor cost.

2. Output or net product approach

This approach is based on the census of production. It measures the value of all goods and services produced in a country during the year. To avoid double counting, income is measured on a value-added basis. Value added is the value of output less the cost of input.

National income derived in this way gives the GDP at market prices. To get the GDP at factor cost, we subtract taxes and add subsidies.

3. Expenditure approach

This is the calculation of the total monetary value of expenditure on goods and services by government, individuals, organisations and others within a country in a given period. Expenditure on intermediate goods and services bought and used for further production must be excluded. This avoids double counting, so the calculation should include only the monetary value of final goods and services.

Why does a country measure its national income?

1. It indicates the standard of living of the country through the measure of per capita income.
2. It helps the country to determine the growth rate of the economy.
3. The national income estimate is vital for economic policy and planning.
4. Measurement through the output approach enables the country to know the performance of the various sectors of the economy.
5. The national income data gives an idea of the pattern of expenditure of households.
6. It influences foreign investment. Foreign investors usually seek countries with rich or fast-growing markets.
7. It forms the basis for contributions to international organisations.

What problems are associated with national income measurement?

1. Income distribution: National income figures do not reveal how income is distributed. The estimate does not indicate whether income is widely spread or concentrated in a few hands.
2. Differences in the internal value of money: The standard of living depends to a large extent on the value of money.
3. Double counting: At times it is difficult to differentiate capital goods from consumer goods. They are therefore counted twice, which gives a false national income.
4. Determining what income is: It is difficult to decide what is income to a person, what constitutes economic activities, and how to value the rewards for services such as those of full-time housewives, subsistence farmers and the self-employed.
5. The self-employed: Many self-employed people in our society do not keep proper books of account, so it is very difficult to ascertain their incomes, expenditures and outputs.
6. Inflation and deflation: Inflation raises national income figures, while deflation reduces them. The problem is how to arrive at an accurate national income figure that is not affected by either.
7. Determining depreciation value: Many business units and individual ventures cannot calculate the depreciation of their machinery, which makes it difficult to ascertain the true position of a country’s national income.
8. Insufficient statistical data: It is extremely difficult to collect and assemble the information required for national income computation. In most cases, the information is not available.
9. Ignorance and illiteracy: These make a majority of the people in West Africa unwilling to supply the basic information used for the computation of national income.
10. Differences in the structure of production.

What are standard of living, cost of living and price index?

Standard of living

Standard of living is the level of welfare attained by individuals in a country at a particular time. This level of welfare is measured in terms of the quantity and quality of goods and services consumed within a period.

The average standard of living in a country is partly determined by the income per head and the distribution of income.

Cost of living

An individual’s cost of living is the total amount of money spent to obtain the goods and services that enable him to exist at a particular time. It depends on the prices of the goods and services which the individual consumes.

Price index

The price index is a number used to show the average rise and fall of prices in percentage terms in relation to a base period.

Index number = (Current year price / Base year price) × 100

Evaluation

1. Define national income and state how it differs from government income.
2. State the difference between GDP and GNP.
3. Explain the three approaches to measuring national income.
4. List four reasons why a country measures its national income.
5. State four problems associated with national income measurement.

Assignment

1. GDP at market prices plus net factor income from abroad gives ___ (a) gross capital formation (b) net capital formation (c) disposable income (d) gross national product.
2. GNP less depreciation is known as ___ (a) Gross Domestic Product (b) Gross National Income (c) Fixed National Income (d) Net National Product.
3. In calculating the GNP by the income approach, all the following are included except ___ (a) wages and salaries (b) direct taxes paid by persons and companies (c) rents on houses (d) retirement benefits (e) business profits.
4. NNP is equal to the ___ (a) GDP less depreciation (b) GNP less depreciation (c) GDP plus depreciation (d) GNP plus depreciation (e) GNI plus taxation.
5. The difference between the GDP and the GNP is the ___ (a) allowance for total depreciation (b) total interest payment (c) net income from abroad (d) total tax and interest payments (e) net internally generated income.