Chapter 7: Determine national income

National income is a critical economic indicator that reflects the overall economic performance of a country, providing vital information for policy makers, investors, and project managers. For project management professionals in Kenya, understanding national income is essential as it influences government spending, investment decisions, and the economic environment in which projects operate. This chapter focuses on defining national income and exploring the various methods used to measure it, enabling project managers to evaluate economic conditions and make informed decisions in their projects.

7.1 Concept of national income

National income is the total value of the goods and services produced by an economy in a year, measured in money and viewed as the income that production creates. Every sale pays someone: wages go to workers, rent to owners of land and buildings, interest to lenders and profit to the owners of firms. Adding all these incomes gives one figure for the whole economy. A project manager reads the trend in this figure as a sign of how much clients, government departments and households are likely to spend on new projects, and how costs for labour and materials may move.

Different measures are used because the question "how much did the economy produce?" can be answered inside or outside the borders, before or after the wear on machines, and at the prices buyers pay or at the cost of the factors of production. Each measure is built from the one before it.

How the main measures are linked

Final goods and intermediate goods

Only final goods and services, those bought by their end user, are counted. A good used up in making another, such as cement bought by a block maker, is an intermediate good, and its value is already inside the price of the finished product. Counting both would count the same value twice, so national accounts add up the value added at each stage of production.

Factors that determine the size of national income

• Natural resources: Land, minerals, water and climate set what an economy can produce.
• Labour force: The number, skills and health of workers set how much output is possible.
• Capital stock: Machinery, roads, power and buildings raise the output of each worker.
• Government policies: Taxes, subsidies and investment incentives change how much firms produce and invest.
• External trade: Export earnings add to income, and imports use some of it.

7.1.1 Gross Domestic Product (GDP)

GDP is the total market value of all final goods and services produced inside a country's borders in a period, normally a year, whoever owns the firms that produce them. A foreign-owned construction firm building a road in Kenya adds to Kenya's GDP, and a Kenyan firm building a road abroad adds to the GDP of the country where the road stands. GDP is a widely quoted measure of the size and growth of an economy. In Kenya the Kenya National Bureau of Statistics compiles the national accounts.

Value added and double counting

Suppose a quarry sells stone to a block maker for Ksh 300 thousand, the block maker sells blocks to a builder for Ksh 700 thousand, and the builder sells the completed house to a household for Ksh 2,000 thousand. Only the house is a final good.

Value added by the quarry = Ksh 300 thousand
Value added by the block maker = 700 − 300 = Ksh 400 thousand
Value added by the builder = 2,000 − 700 = Ksh 1,300 thousand
Total value added = 300 + 400 + 1,300 = Ksh 2,000 thousand

The total value added equals the price of the final good, so GDP rises by Ksh 2,000 thousand and not by Ksh 3,000 thousand.

What GDP leaves out

• Intermediate goods: They are counted once, through the final good.
• Transfer payments: Pensions and gifts are not payment for production.
• Second-hand sales: A used excavator sold from one contractor to another was counted when it was made. Only the dealer's fee is new production.
• Unrecorded activity: Unpaid housework and much informal trade are not captured in full.

Nominal and real GDP

Nominal GDP uses the prices of the year in which the output was produced, so it can rise only because prices rise. Real GDP removes price changes and shows the true change in output. Real GDP = nominal GDP ÷ GDP deflator × 100.

Example: in a hypothetical economy nominal GDP is Ksh 3,600 billion and the GDP deflator is 120.

Real GDP = 3,600 ÷ 120 × 100
Real GDP = Ksh 3,000 billion

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

GNP measures the output of a country's residents wherever in the world they work or invest. It is found by adding net factor income from abroad to GDP. That figure is the income residents earn abroad, such as profits of a Kenyan engineering firm's foreign branch and the pay of Kenyans working overseas, less the income that foreigners earn in Kenya and send out. GNP = GDP + net factor income from abroad.

NNP deducts depreciation from GNP. Equipment, vehicles and buildings wear out as they are used, so part of each year's output must replace them, and only the remainder is new output. NNP = GNP − depreciation.

Example: in a hypothetical economy GDP is Ksh 3,000 billion, residents earn Ksh 240 billion abroad, foreigners earn Ksh 190 billion in the country, and depreciation is Ksh 300 billion.

Net factor income from abroad = 240 − 190 = Ksh 50 billion
GNP = 3,000 + 50 = Ksh 3,050 billion
NNP = 3,050 − 300 = Ksh 2,750 billion

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

NNI is the income earned by the factors of production in a year after depreciation has been taken off. It is stated in two ways, according to whether taxes and subsidies on production are included.

NNI at market price

NNI at market price equals NNP at market prices. These are the prices buyers pay, so they include indirect taxes such as value added tax (VAT) and excise duty, and they are reduced by subsidies given to producers. The figure therefore overstates what the factors of production actually received. NNI at market price = GNP at market price − depreciation.

NNI at factor cost

NNI at factor cost is what the owners of labour, land, capital and enterprise earned as wages, rent, interest and profit. Indirect taxes are deducted because they go to the government, and subsidies are added because they raise producers' receipts. This is the figure usually called national income. NNI at factor cost = NNI at market price − indirect taxes + subsidies.

Example: using the NNP of Ksh 2,750 billion above, indirect taxes are Ksh 270 billion and subsidies are Ksh 45 billion.

NNI at factor cost = 2,750 − 270 + 45
NNI at factor cost = Ksh 2,525 billion

7.1.4 Disposable income

Disposable income is what households have left to spend or save after paying direct taxes and compulsory deductions, with transfer payments received added. It is the figure that sets how much households can spend, so it guides firms that sell to them. A rise in disposable income increases demand for housing, furniture and vehicles, which in turn increases the work available for contractors.

From national income to disposable income

National income does not all reach households. Companies keep part of their profits, the government takes taxes and social security contributions, and households receive pensions and other transfers. Personal income = NNI at factor cost − undistributed profits − corporate taxes − social security contributions + transfer payments. Disposable income = personal income − personal direct taxes, such as income tax.

Uses of disposable income

Disposable income is spent on consumption or saved, so disposable income = consumption + saving.

Example: a site engineer's gross monthly pay is Ksh 120,000 and Ksh 30,000 goes in income tax and other statutory deductions.

Disposable income = 120,000 − 30,000 = Ksh 90,000
If Ksh 70,000 is spent, saving = 90,000 − 70,000 = Ksh 20,000

Chapter Summary

National income represents the total value of goods and services produced by a country within a specific period, and it can be measured through several key concepts including Gross Domestic Product, Gross National Product, Net National Product, Net National Income at both market price and factor cost, as well as disposable income. Various methods are employed to calculate national income, notably the income approach, which sums all incomes earned; the output approach, focusing on total production; and the expenditure approach, which totals all spending on final goods and services. Measuring national income involves challenges such as data accuracy, informal economic activities, and valuation difficulties. Despite these challenges, national income statistics are crucial for economic planning, policy formulation, and assessing a country's economic performance. The chapter also examined the concept of national income equilibrium, which occurs when total output equals total income, ensuring economic stability. Understanding these principles provides a comprehensive foundation for analyzing a nation’s economic health and guiding development strategies.