National income is a cornerstone concept in economics that reflects the total value of goods and services produced by a country within a specific period. For procurement management professionals in Kenya, understanding national income is vital as it influences government spending, taxation policies, and economic stability, all of which directly affect procurement budgets and contract negotiations. This chapter explores the concept of national income and the various methods used to measure it, providing procurement managers with the analytical tools necessary to interpret economic trends and make informed decisions.

7.1 Concept of national income

National income is the total money value of all final goods and services produced by a country's resources during a given period, usually one year, which is also the total of the incomes (wages, rent, interest and profit) earned by the owners of those resources. Because the value of what is produced is paid out as income to the factors of production, the same total can be viewed as output, as income or as expenditure. Several related measures are used, depending on whether production inside the country or by its residents is counted, whether wear and tear of capital is deducted, and whether market prices or factor costs are used. These measures, and how they link to one another, are set out below; the methods of measuring them are covered in 7.2.

Basic ideas

• Final goods only: Only goods and services sold to final users are counted; intermediate goods (timber bought by a furniture maker, flour bought by a bakery) are left out to avoid double counting.
• Period: National income is a flow measured over a period, usually a year or a quarter.
• Money value: Different goods are added by their money values; changes in prices must be removed to compare real output between years.
• Factor incomes: Wages and salaries (labour), rent (land), interest (capital) and profit (entrepreneurship).
• Circular flow: Firms pay incomes to households, and households spend them on the firms' output, so output, income and expenditure are equal.

7.1.1 Gross Domestic Product (GDP)

Gross Domestic Product is the total market value of all final goods and services produced within the geographical boundaries of a country in a given period, whoever owns the resources. It includes output by foreign-owned firms operating in the country, and excludes output by the country's citizens and firms abroad. "Gross" means no deduction has been made for depreciation of capital. GDP is the most widely used measure of the size of an economy and of economic growth.

Features of GDP

• Domestic territory: Counts production within the country's borders.
• Gross: Depreciation (capital consumption) is not deducted.
• Market prices or factor cost: GDP at market prices includes indirect taxes and excludes subsidies; GDP at factor cost = GDP at market prices − indirect taxes + subsidies.
• Nominal and real: Nominal GDP uses current prices; real GDP removes the effect of price changes by using the prices of a base year.
• Growth: The percentage change in real GDP from one year to the next is the economic growth rate.

Example: if real GDP rises from Ksh 12,000 billion to Ksh 12,600 billion, the growth rate = (12,600 − 12,000) ÷ 12,000 × 100 = 5%.

7.1.2 Gross national product (GNP) and net national product (NNP)

Gross National Product is the total market value of final goods and services produced by the residents of a country, whether the production takes place at home or abroad, in a given period. It is found by adding to GDP the incomes residents earn from abroad and subtracting the incomes foreigners earn in the country. The difference between the two is called net factor income from abroad (NFIA).

GNP = GDP + factor incomes received from abroad − factor incomes paid abroad

GNP = GDP + NFIA

Net National Product is GNP less depreciation, the value of capital (machines, buildings, vehicles) used up in producing the year's output. It shows the output available for consumption and new investment after worn-out capital has been replaced.

NNP = GNP − depreciation (capital consumption)

Points to note

• NFIA may be positive or negative: A country whose firms and workers earn more abroad than foreigners earn in it has GNP above GDP; where profits and interest paid to foreign investors are larger, GNP is below GDP.
• Factor incomes from abroad: Include wages of residents working abroad for short periods, and profits, interest and dividends from investments abroad.
• Depreciation is estimated: It is based on the expected lives of capital assets, so NNP is less precise than GNP.
• NNP is a better measure of sustainable output: A country could raise GNP by not replacing capital, but NNP would show the run-down.
• Both can be at market prices or factor cost: As explained in 7.1.3.

7.1.3 Net national income (NNI) at market price and factor cost

Net national income at market prices is the same total as net national product at market prices: the net value of the output of residents valued at the prices buyers pay. Market prices include indirect taxes, such as VAT and excise duty, and are reduced by subsidies, so they do not show what the factors of production actually received. Net national income at factor cost removes these: it is the total of the incomes earned by the factors of production (wages, rent, interest and profit) and is what economists usually mean by "national income".

NNI at market prices = NNP at market prices = GNP at market prices − depreciation

NNI at factor cost = NNI at market prices − indirect taxes + subsidies

Worked example: from GDP to national income

A hypothetical economy has the following figures for one year (Ksh billion):

NFIA = 200 − 500 = −300

GNP at market prices = 15,000 + (−300) = 14,700

NNP (NNI) at market prices = 14,700 − 1,200 = 13,500

NNI at factor cost = 13,500 − 1,800 + 200 = 11,900

National income at factor cost is Ksh 11,900 billion.

7.1.4 Disposable income

Disposable income is the income that households actually have available to spend or save after paying personal direct taxes. It is found by first working out personal income, the income households actually receive, and then deducting the taxes they pay. Disposable income is the main determinant of household consumption, and so of the demand for goods that firms and their suppliers produce.

Personal income = National income − undistributed company profits − corporation tax − social security contributions + transfer payments

Disposable income = Personal income − personal direct taxes (income tax)

Disposable income = Consumption + Saving

Items in the calculation

• Undistributed profits: Profits kept by companies and not paid to households as dividends.
• Corporation tax: Tax on company profits, which does not reach households.
• Social security contributions: Deductions such as pension and health insurance contributions.
• Transfer payments: Payments received without producing anything in return, such as pensions, social assistance and bursaries; they are not part of national income but add to personal income.
• Personal direct taxes: Income tax (PAYE) and other taxes on personal income.

Worked example: disposable income

Continuing the example above (Ksh billion): undistributed profits 500, corporation tax 600, social security contributions 300, transfer payments 400, personal income tax 1,500, and household consumption 8,600.

Personal income = 11,900 − 500 − 600 − 300 + 400 = 10,900

Disposable income = 10,900 − 1,500 = 9,400

Saving = 9,400 − 8,600 = 800

Summary of the measures

Chapter Summary

This chapter explored the concept of national income by defining key measures such as Gross Domestic Product, Gross National Product, Net National Product, Net National Income at both market price and factor cost, and Disposable Income. It then examined the three primary methods used to measure national income: the income approach, which sums earnings from production; the output approach, which totals the value of goods and services produced; and the expenditure approach, which adds up spending by different sectors. The chapter also highlighted the challenges encountered in accurately calculating national income, including data collection difficulties and informal economic activities. Furthermore, the significance of national income statistics was discussed, emphasizing their role in informing government policy and economic planning. Finally, the concept of national income equilibrium was introduced, explaining how the balance between aggregate demand and aggregate supply determines economic stability.