National Income - Business Studies Form 3 Notes

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  • The total income received by the owners of the factors of production in a given country over a given period of time usually one year. It is the same as National output or national product.

Terms Used in National Income

Gross Domestic product (GDP) and Net Domestic Product (NDP)

  • GDP refers to the total monetary value of all goods and services produced in a country over a period of one year.
  • Net Domestic Product is equal to gross domestic product less depreciation.

Gross National Product (GNP) and Net National Product (NNP)

  • Gross National Product measures the total monetary value of all 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 aboard (export less imports).
  • Net national product is the gross national product less value of capital used in the production process (depreciation)
    NNP = GNP - Depreciation.

Per Capita Income.

  • The average income per head per year in a given country.

    Per capita income = National income/total population.

The Circular Flow of Income.

  • The movement of income from households to the firm and then back to the households is known as the circular flow of income.
  • The flow money (income) round the economy is shown by the dotted lines while the flow of goods and factor services is shown by continuous (inside) line.

Assumptions Made for the Circular Flow of Income to Hold.

  • There are only two sectors in the economy that is households and firms.
  • Households spend all their income on goods and services produced by the firms.
  • Firms spend all their revenues on factors of production provided by the household.
  • There is no government intervention.
  • The economy is closed, that is no foreign trade.

- The assumptions do not hold because of the following

  • No country can exist without dealing with other countries.
  • It is difficult to have an economy where all incomes are spent on only acquisition of goods and services without savings and investments.
  • It is not possible to have an economy where the government does not take part


  • They are factors that increase income and expenditure in the circular flow are referred to as injections.
  • They include:
    • Investments
    • Government spending
    • Exports


  • The factors that reduce the volume of flow are referred to as withdrawals/leakages.
    • Savings
    • Taxation
    • Imports

Factors that Affect the Circular Flow of Income

  1. Savings
    - Savings by households reduce income received by firms since they have been withdrawn from the circular flow.
  2. Government
    - The government affects the circular flow by either taxation which reduce the amount of income available for spending or through government expenditure.
  3. Investment
    - Firms borrow money that households have saved in financial institutions such as banks and use it to invest. The investments leads to higher income to households since the capital goods are either hired or bought from households.
  4. Foreign trade
    - Through exports a country is able to earn income from other countries. The income earned from the foreigners is an addition to the circular flow of income and hence an injection.

Equilibrium National Income

  • The national income equilibrium is achieved when total injections are equal to total withdrawals (leakages).
  • For national income to be in equilibrium the following equation must be satisfied.
    Savings + taxes + imports = investments + exports + government expenditure.

Measurement of National Income

- National income may be measured using the following methods.

Expenditure Approach

- The national income is arrived at by adding together the expenditure on all final goods and services in the economy.
- The total expenditure is broken into the following stages:

  1. Expenditure on consumer goods by the general public (C).
  2. Expenditure on capital goods. Capital goods are also called investments denoted by letter (l).
  3. Government expenditure which may be divided into expenditure on goods and services from firms and expenditure on factor services from households. Government is denoted by (G)
  4. Expenditure on net exports.Net exports are atotal exports less total imports.Its denoted by the expression ( X – M ).

National income = C + I + G + ( X – M)


  • Only expenditure on new goods is added in the calculation while expenditure on second hand goods is not added as no production has taken place.
  • The national income arrived at using the expenditure approach is at market price because it involves expenditure on final goods and services thereby including indirect taxes and subsidies in order to get the national income at factor cost, subsidies are added while indirect taxes are subtracted.

    G.N.E at factor cost = C + I + G + (x – m) + (subsidies – Indirect taxes)
  • To get net national expenditure/national income capital consumption (depreciation) is subtracted from Gross National Expenditure.
    Thus: National income = Gross National Expenditure – Depreciation

Problems Associated with the Expenditure Approach

  1. No accurate records of expenditure are kept especially in the private sector.
  2. Expenditures for the subsistence sectors are only approximations due to lack of records in the sector.
  3. Differentiating between final expenditure and intermediate expenditure may be difficult.
  4. Suffers from the problem of double counting.
  5. Fluctuating exchange rates may pose challenges especially in valuation of exports and imports.

Income Approach

  • Income approach takes into account the sum of money that is received as income by different individuals who contribute to the production of goods and services. The incomes include rent, interest, wages and profit.
  • In addition public income and retained profits are included, it should be noted that transfer payments are excluded from the final calculations of national income because they represent a redistribution of incomes from those who have earned them to the recipients
  • Such income include, national insurance and social security benefits to individuals, student‟s grants and pocket money.
  • National income may be calculated as:
    G.N.I = personal income + retained profit – (transfer payments + stock appreciation).
  • The national income arrived at using this method is at factor cost because it represents the actual payments to the factors of production. In order to get national income at market price,indirect taxes are added and subsidies subtracted.
  • Gross National income is got by adding the net income from abroad to gross Domestic product.
    Thus .G.N.I = GDP + ( x – m )
  • To arrive at the net National income or simply National income, capital consumption
    (Depreciation) is subtracted from Gross National income.
    Thus, N.I = G.N.I – depreciation.

Problems Associated With The Income Approach

  1. Problem of inaccurate data
  2. Price fluctuations make it difficult to calculate national income.
  3. Problem of handling illegal and unrecorded yield income to recipients.
  4. Transfer payments pose a problem
  5. Income disclosures aren‟t true because people and firms like evading tax

Output Approach(Value Added)

  • The national income is arrived at by adding up the values of all final goods and services produced by firms during the year or it may be calculated by adding up the values to the product at each stage of production.
  • Government contribution to the national output is also taken into an account. Such services include education, health care and security. To find their value we get what it cost the government to provide them.
  • The GDP aimed at using this method is a factor cost as it excludes subsidies and indirect taxes. To arrive at the Gross National Product, Net Income from abroad is added to the Gross Domestic Product
    Thus, GNP = GDP + (x-m)
  • To get the Net National Product/National Income depreciation is subtracted from the gross National product.
    National Income = GNP – Depreciation

Problems with the Output Approach

  1. Problems of valuation due to unavailability/inaccuracy of output figure especially in the private section.
  2. Problem of deciding on the goods/services to include eg. Whether the output of a house wife should be included or not.
  3. The problem of valuing output in the subsistence sector.
  4. Problem of frequent changing process.
  5. Problem of valuing government output since many of its services are not sold in the market.
  6. Problems of differentiating primary inputs from intermediate inputs.
  7. Valuing illegal activities like drug trafficking.

National Income Statistics

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

Uses of National Income Statistics

  1. Use to measure rate of economic growth of a country. When output figures are high it means productivity has improved.
  2. Helps the government to plan its economy since it provides useful information required by planners.
  3. Used to compare the standards of living of people in a country. By comparing the per capita figures.
  4. Help the country to know the size and contribution of various sectors to natural income hence can take appropriate measures to improve them.
  5. Shows the progress of the economy over a given period by comparing national income statistics over given period.

Disadvantages of Using National Income to Compare Standards of Living in Different Countries.

  1. Different currencies
    - Conversation of currencies may be tedious.
  2. Different goods and services
    - The type of goods and services that are used to compute national income may differ from country to country.
  3. Disparity in distribution of income
    - Although income per capita may be similar in both countries, standards of living may differ considerably because of disparity in income distribution.
  4. Different needs and tastes
    - National income statistics may not give a true and a fair picture of standard of living due to different in taste and needs of the people.

Factors that Influence the Level of National Income

  1. Labour supply
    - A country with more labour produces more than a country with less labour and also a country with more skilled labour force would produce high quality goods and services than a country with less skilled labour force.
  2. Capital
    - A country which uses modern equipment such as tractors in ploughing, would be able to produce more than a country using simple tools like jembes. This is because capital varies from simple tools to modern equipment‟s.
  3. Entrepreneurship
    - Availability of Entrepreneurs who have the ability to organize the factors of production in correct proportions, make their output to increase thereby increasing the national income.
  4. Availability of natural resources
    - The size of national income of a country depends on the natural resources endowment of that country. Therefore a country with abundant resources is likely to have a higher national income relative to a country without.
  5. Level of technology
    - If advance technology and latest equipment used in the process of production, then more goods can lie produced, which increase the volume or size of national income.
  6. Political stability.
    - If there is political stability in the country, the production can be sustained at the highest level and the size of national income will be large. In case of political condition is not good the production will be adversely affected and so the size of national income will be small.
  7. 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 hard working.

Past KCSE Questions on the Topic

Paper 1

  1. Outline four reasons why an increase in per capita income may not necessarily lead to a rise in the standard of living of the citizens
  2. State four factors that affect the circular flow of income in an economy
  3. Identify four factors that may be contributing to income disparity between the rich and poor citizens in Kenya
  4. Account for the difference between the gross National Income figures between Kenya and Uganda
  5. Name three approaches for measuring national income
  6. Highlight four problems associated with income approach
  7. Highlight four problems associated with the output approach in computation of National income
  8. Highlight four uses of National Income statistics in any given country
  9. Outline four circumstances under which per capita income would be a good indicator
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