Chapter 7: Determine national income

National income is a vital indicator of a country’s economic performance and overall well-being. For business management professionals in Kenya, understanding national income enables informed decision-making, strategic planning, and evaluation of market potential. This chapter explores the concept of national income and the various methods used to measure it, providing essential knowledge that supports business analysis and policy assessment.

7.1 Concept of national income

National income is the total money value of the final goods and services that the people and firms of a country produce in a period, usually one year. Only final goods count, because the value of intermediate goods, such as the timber a furniture workshop buys, is already inside the price of the finished table. Counting both would be double counting.

There is no single figure called "national income". Economists work with a family of measures: gross domestic product, gross national product, net national product, net national income and disposable income. Each is reached from the one before by adding or subtracting one item. A business manager who knows how they connect can read a news report on the economy and judge what it means for demand, costs and expansion plans.

Example: A hypothetical economy produces goods and services worth Ksh 1,200 billion inside its borders in a year. The rest of this topic uses these figures to move from that gross figure to the income households finally have to spend.

7.1.1 Gross Domestic Product (GDP)

Gross Domestic Product is the total market value of all final goods and services produced within a country's borders in a given period, whoever owns the firms that produce them. "Gross" means that nothing has yet been deducted for the wearing out of machinery and buildings. "Domestic" means the test is location: a workshop in Kenya that is owned by a foreign investor adds to Kenya's GDP, and a Kenyan firm operating in another country does not.

What GDP counts and leaves out

GDP is built on a few simple rules that explain most questions about it.

• Final goods and services only: Sales of finished products to the end user are counted. Timber sold to a workshop is left out, and the table made from it is counted at its full selling price.
• Current production only: A second-hand vehicle sold this year was counted in the year it was made. Only the dealer's commission or margin on the sale is new production.
• Market value: Each item is valued at its market price, so a table sold at Ksh 50,000 adds Ksh 50,000 and a haircut sold at Ksh 500 adds Ksh 500.
• Production, not transfers: Pensions, bursaries, remittances from relatives and other transfer payments are not payments for production, so they do not enter GDP.
• A fixed period: GDP is a flow measured over a quarter or a year, like water running through a pipe, not a stock like water in a tank.

Example: A sawmill sells timber worth Ksh 20,000 to a workshop. The workshop makes a table from it and sells it for Ksh 50,000. GDP rises by Ksh 50,000, not Ksh 70,000. The same Ksh 50,000 can be reached by adding the sawmill's contribution (Ksh 20,000) and the workshop's contribution (Ksh 30,000).

Why GDP matters to a manager

Managers watch changes in GDP over time as a sign of whether the market is growing or shrinking. Rising GDP usually means more employment and spending, which supports sales. Falling or flat GDP warns of weaker demand and tighter credit, which affects stock levels, hiring and borrowing decisions. GDP figures are published at current prices and at constant prices, and the difference is explained in Problems of national income. The three ways of calculating GDP are covered in Methods used to measure national income.

What a single GDP figure does not show

GDP is a total, and a total hides detail. It does not show how income is shared between rich and poor households. It places no value on unpaid work in the home. It does not subtract damage to the environment, such as soil loss or polluted rivers, that production may cause. A rise in GDP therefore does not always mean a rise in welfare, so managers read GDP alongside other indicators.

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

Gross National Product measures the output of a country's own citizens and firms wherever in the world they operate. The test is ownership, not location. It is found by adjusting GDP for income that crosses the border:

GNP = GDP + net factor income from abroad

Net factor income from abroad is the income that residents earn from abroad (profits, interest, wages and rent) minus the income paid out to non-residents for the use of their factors of production in the country.

Net factor income from abroad

A Kenyan transport firm that earns profits from routes in a neighbouring country adds to GNP, because the owners are Kenyan. A foreign-owned hotel in Kenya adds to Kenya's GDP, but the profit it sends home to its owners is deducted when GNP is calculated. When residents earn more abroad than foreigners earn in the country, GNP is larger than GDP. When more income flows out than flows in, GNP is smaller than GDP.

Example: Residents of the hypothetical economy earn Ksh 90 billion from abroad, and foreign owners of firms in the country take out Ksh 40 billion. Net factor income from abroad is 90 − 40 = Ksh 50 billion. GNP = 1,200 + 50 = Ksh 1,250 billion.

Net national product (NNP)

Machines, vehicles and buildings wear out as they are used, and part of each year's output only replaces them. This loss in value is depreciation, also called capital consumption. Net National Product is the output that remains after replacing worn-out capital:

NNP = GNP − depreciation

Example: A printing workshop buys a machine for Ksh 600,000 that is expected to last 5 years with no resale value. Straight-line depreciation is 600,000 ÷ 5 = Ksh 120,000 a year. If all the workshops, farms and factories in the hypothetical economy lose Ksh 150 billion in value in the year, NNP = 1,250 − 150 = Ksh 1,100 billion.

Comparing GDP, GNP and NNP

NNP is the more useful guide to what the country can consume or invest without becoming poorer, because it counts only what is left after maintaining the capital stock.

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

Net national income is the income earned by a country's residents from producing goods and services in a year, after depreciation. It can be stated in two ways, depending on whether taxes and subsidies on production are included in the valuation.

NNI at market price

NNI at market price values output at the prices consumers actually pay in shops and markets. These prices include indirect taxes, such as excise duty and value added tax, and they are lowered where the government pays subsidies. For this reason NNI at market price is the same figure as NNP at market price:

NNI at market price = GNP at market price − depreciation

Example: In the hypothetical economy, NNI at market price = 1,250 − 150 = Ksh 1,100 billion.

NNI at factor cost

Taxes on production and products go to the government, not to the people who produced the goods, so they are not income earned by workers or owners. Subsidies work the other way: they add to producers' income without being included in the price paid. To measure only what the factors of production earned, indirect taxes are removed and subsidies are added back:

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

Example: Indirect taxes are Ksh 120 billion and subsidies are Ksh 20 billion. Net indirect taxes are 120 − 20 = Ksh 100 billion.

NNI at factor cost = 1,100 − 120 + 20 = Ksh 1,000 billion.

NNI at factor cost is the figure most often meant when economists speak of national income.

Components of national income at factor cost

Factor cost income is shared among the owners of the factors of production. The main components are:

• Compensation of employees: Salaries, wages and benefits paid to workers, which reflect labour's contribution to production.
• Rent: Income earned from leasing land and buildings, which is important in farming and in property.
• Interest: Payments received by lenders for the use of their capital.
• Profit: The earnings of business owners after costs, which reward enterprise and risk taking. Income of the self-employed and of unincorporated businesses is counted with profit.

Example: Compensation of employees Ksh 560 billion, rent Ksh 90 billion, interest Ksh 70 billion and profit Ksh 280 billion give 560 + 90 + 70 + 280 = Ksh 1,000 billion, which agrees with NNI at factor cost above. The income method of measuring national income uses this same list and is explained in Methods used to measure national income.

7.1.4 Disposable income

Disposable income is the income that households have left to spend or save after paying direct taxes. It is the figure that most directly drives consumer demand, so managers selling to households follow it closely.

From national income to disposable income

Not all of the income earned in production reaches households. Firms keep some profit, the government takes taxes from firms and workers, and households also receive money that was not earned in production. Personal income is found as follows:

Personal income = NNI at factor cost − undistributed profits − corporate taxes − social security contributions + transfer payments

Disposable income = personal income − personal direct taxes

Example: In the hypothetical economy, undistributed profits are Ksh 60 billion, corporate taxes Ksh 50 billion and social security contributions Ksh 40 billion. Transfer payments received by households, such as pensions and remittances, are Ksh 100 billion.

Personal income = 1,000 − 60 − 50 − 40 + 100 = Ksh 950 billion.

Personal direct taxes are Ksh 130 billion, so disposable income = 950 − 130 = Ksh 820 billion.

Uses of disposable income

Households use disposable income in only two ways:

Disposable income = consumption + saving

Example: Of the Ksh 820 billion, households spend Ksh 700 billion on consumption and save Ksh 120 billion, and 700 + 120 = 820.

Disposable income of a single household

The same idea applies to one worker. Example: An employee of a hardware shop earns Ksh 60,000 a month. Income tax and other statutory deductions come to Ksh 12,000, and the employee receives Ksh 5,000 a month from a relative. Disposable income = 60,000 + 5,000 − 12,000 = Ksh 53,000. If the employee spends Ksh 41,000 on rent, food, transport and other needs, saving is 53,000 − 41,000 = Ksh 12,000.

Why disposable income matters to a manager

When disposable income rises, households buy more, and demand for goods and services that people regard as non-essential tends to rise the most, such as eating out or home improvements. When it falls, households protect spending on food and rent and cut back elsewhere. A manager who tracks changes in tax rates, wages and the cost of living can forecast sales and set prices with more confidence.

Chapter Summary

This chapter examined the concept of national income by defining key measures such as Gross Domestic Product, Gross National Product, Net National Product, Net National Income at market price and factor cost, and Disposable Income. It explored the three main methods used to measure national income: the income approach, the output approach, and the expenditure approach, highlighting how each captures different economic activities. The chapter also addressed common problems encountered in calculating national income, including data collection challenges and valuation issues. The significance of national income statistics was emphasized, particularly their role in informing government policy, economic planning, and assessing economic performance. Finally, the concept of national income equilibrium was discussed, explaining how the balance between total output and total expenditure affects economic stability. Together, these topics provide a comprehensive understanding of national income and its measurement within an economy.