NATIONAL INCOME

Definition of national income

National income refers to the measure of the total monetary value of all the goods and services which arise
from the economic activities of the country in a given period of time usually a year.
when estimating national income, the following points should be noted.
 national income is a flow and not a stock of goods and services. the output of goods and services
is a continous process so that in trying to measure what is produced, we are dealing with a flow
and not a sctock of goods and services. this should therefore be measured over time usually in one
year.
 national income includes goods and services. therefore production is defined aas an economic
activity which leads to the creation of utility in goods and services in order to satisfy human wants
and for which people are prepared to pay the price.
 national income is measured in monetary terms. however it is the value of the commodity which
is important and not the money itself.
 national income figures exclude incomes from illegal activities like prostition and gambling.
 only the market prices of the final goods and services are considered. this is intended to avoid
double counting since production takes many stages before reaching the final consumer.
 income should be derived from goods and services arising out of productive activities. therefore
incomes received from for no wordone for example pocket money for students, pension,
unemployement benefits, bursaries gifts from friends and transfer payments should be excluded
when estimating national income.
 incomes should be from transactions of a particular current period. those arising from periods other
than the current period should be excluded.

DETERMINANTS OF NATIONAL INCOME

The level of investment both domestically and externally. the higher the level of investment, the higher
the level of national income but a low level of investment discourages production of goods and services
hence low levels of national income.
The level of exploitation and utilization of the available natural resources. The higher the level of
utilization of natural resources like minerals and water resources in the economy, the higher the level of

120 | P a g e
national income and the lower the level of utilization of natural resources, the lower the level of national
income.
The size and quality of the labour force (working population), Presence of a big and skilled labour force
increases production of goods of services which leads to an increase in national income, 0n the other hand,
a small-unskiiled labour force discourages production hence low levels of income
Level of capital stock. Availability of capital in form of machinery and equipment increases the level of
output and national income while presence of limited capital stock limits production hence low level of
National Income.
The level of technological progress, Use of better and improved technology increases production at
reduced average costs hence giving a bigger size of national income, On the other hand, use of poor
production techniques reduce output hence low level of national income
Degree of political stability. Political stability encourages investment and growth of national income while
political instability leads to break down in production by discouraging investment hence a smail size of
national income.
Market size within and outside the country, The large market encourages investors which lead to the
production of more goods and services hence increasing national income. But a small market discourages
investment and production hence low level of nationalincome.
The level of monetization of the economy. The higher the level of monetization of the economy, the higher
the level of national income, But a large subsistence sector discourages production and exchange hence
low levels of income.
Level of specialization in production, The higher the level of specialization in the economy, the higher the
level of national income and the lower the level of specialization, the lower the level of national income
The level of entrepreneurial ability. Presence of individuals who can organize and mobilize other factors
of production leads to an increase in production hence an increase in national income and absence of
entrepreneurial skills discourages production hence low levels of national income. Degree of economic
stability. A country which is economically stable in form of stable prices of goods and services encourages
investments hence increase in the level of national income. But existence of high levels of inflation
discourages investments hence low levels of national income.

121 | P a g e
Concepts (Terms) used in National income
Gross Domestic Product (GDP), This refers to the money value of all final goods and services produced
within the geographical boundaries of the county by both nationals and foreigners in a given time, usually
one year including the value of depreciation.
GDP=C+I+G
Where, C = Consumption (Household) sector,
I = Investment (Buslness) sector and G = Government sector
It considers a closed economy, that is, an economy with no international transactions
Gross national product. this refers to the money value of all the final goods and services produced by
nationals living within and outside the country in a given time.
GNP=C+I+G+(X-M)
Net property income. this is the difference between the property (factor) incomes earned from by the
nationals from abroad and the property incomes paid by the national abroad.
NPY=GNP-GDP
Depreciation(capital consumption allowance). this refers to the amount of money (funds) put aside to
replace the worn out parts of capital assests used in the production process.
net domestic product. this refers to the money value of all the final goods and services and services
produced by nationals within and outside the country in a given time usually one year excluding the value
of depreciation.
NNP=GNP-Depreciation
gross domestic product at market price . this refers to the monetary value of all the final goods and
services produced within a country by nationals and foreigners in a given time usually one year including
the value of depreciation, valued at the current market prices of goods and services.
GDPmp=GDPfc+Indirect taxes-subsidies
gross domestic product at factor cost. this refers to the monetary value of all the final goods and services
produced within a country by nationals and foreigners in a given time usually one year including the value
of depreciation, valued at prices of factors of production
GDPfc=GDPmp+Subsidies-indirect taxes
Gross National Product At Market Prices. this refers to the money value of all the final goods and
services produced by nationals living within and outside the country in a given time usually one year
including the value of depreciation, valued at the current market prices of goods and services.

122 | P a g e
GNPmp=GNPfc+indirect taxes-subsidies
Gross National Product At Factor Cost. this refers to the money value of all the final goods and services
produced by nationals living within and outside the country in a given time usually one year including the
value of depreciation, valued at prices of factors of production
GNPfc=GNPmp+ Subsidies-Indirect taxes
Net Domestic Product at Market price(NDPmp). refers to the money value of all final goods and
services produced within the county by both nationals and foreigners in a given time usually one year
excluding the value of depreciation, valued at current market prices of goods and services
NDPmp = NDPfc + Indirect taxes - Subsidies
Net Domestic Product at factor cost (NDPfc). it refers to the money value of all final goods and services
produced within the county by both nationals and foreigners in a given time usually one year excluding
the value of depreciation, valued aiprices of factors of production
NDPfc = NDPmp + Subsidies - Indirect tmes (Outlays)
Net National Productat Market price(NNPmp) .it refers to the money value of all final goods and
services produced by nationals living with in and outside the country in a given time, usually one year
excluding the value of depreciation, valued at current market prices of goods and services
NNPmp = NNPfc + Indirect taxes - Subsidies
Net National Product at factor cost (NNPfc) it refers to the money value of all final goods and seruices
produced by nationals living with in and outside the country in a given time, usually one year excluding
the value of depreciation, valued at prices of factors of production
NNPfc. = NNPmp + Subsidies - Indirect taxes

Adjustments in National income Figures

From gross to nef figures, subtract depreciation value (capital consumption allowance).
From net to gross figures, add depreciation value (capital consumption allowance).
From domestic to national, add net property income from abroad o From national to domestic, subtract
net property income from abroad
From factor cost to market price, add indirect taxes ancl subtract subsidies r From market price to factor
cost, subtract indirect taxes and add subsidies.

123 | P a g e
Personal income, This is the amount of money income received by individual house hold over a given
time
Disposoble income. This is the income that is available to house holds for spending and saving after
personal income taxes and other compulsory payments (for eximple NSSF) have been deducted from the
gross income.

Methods (Approaches) Of Measuring National Income

There are three methods of measuring national income. they include
Income approach
Expenditure approach
Output (product/ value added) approach

INCOME APPROACH
This involves summing up all the incomes or payments to the factors of production (factor earnings) in
arising out of economic activities in the economy in the given year .That is rent, wages, interest and profits
National income = wages (w) + rent(r) + interest (i) + profit( )
Nate. ln order to avoid double counting, transfer payments are excluded from measuring national income
using this approach
Transfer payments refer to incomes received by individuals or institutions without any corresponding
economic exchange of goods and services. For example pension, donations, gifts etc

Limitations (Problems) of using income approach in estimating national income

Lack of information. many people are self employed and they are not willing to declare their income. This
leads to under estimation of national income.

124 | P a g e
It is difficult to estimate incomes earned from abroad
Transfer payments are difficult to identify and yet when included lead to double counting.
Depreciation incurred during the year is difficult to determine yet an allowance for this must be included
when estimating national income. Depreciation represents the cost of production since the asset must be
replaced when it becomes completely won out.
It is also dfficult to identify incomes from illegal activities since they are not supposed be included in
estimating nationalincome

Expenditure Approach
This approach involves summing up the expenditure by different sectors of the economy on final goods
and services produced during a given time usually one year.the approach centers on the component of
final demand which generates production
NY=C+ I +G +(X - M)
where C = Expenditure by private consumers IHouseholds)
I= Expenditure by firms on capitalgoods
G - Expenditure by government on services like education, health, infrastructure etc
X - M = Net export earnings from abroad.
Exports are included because they lead to inflow of income while Imports (M) are excluded because they
lead to outflow of income

limitations (problems) of using the Expenditure approach

it is difficult to differentiate between expenditure on final goods and intermediate goods yet it is only
expenditure on final goods whivh must e included. This is because people do not keep records.
Lack of information on private consumption and investment expenditure.
It is difficult to determine accurate expenditure on imports and this leads to either underestimating or over
estimating national income.
Difficult to identify expenditure on transfer payments which is supposed to be excluded when estimating
national income.

Output/Value Added/Product Approach.

125 | P a g e
This is the most direct and preferred method of estimating national income. It involves summing up the
contributions (value added) of all firms or sectors at each stage of production of final goods and services
in the economy. This is done in order to avoid double counting.

Limitations (Problems) of using the output approach

Lack of information on what is produced by all enterprises or sectors within a year in the economy
There is problem of double counting due to failure of distinguishing between intermediate goods and final
goods. This results into counting the value of the item more than once hence orrer estimating national
income.
Problem of inventories .lnventories are goods produced but not sold in the previous period' The value of
such goods is not supposed to be included when estimiting the national income of the current year,
why most developing countries prefer to use the product approach
Data on output is readily availabie as compared to data on income and expenditure
Individuals are willing to reveal information on output than on income and expenditure
It eliminates double counting since only value added is considered
The approach is not affected by transfer payrnent as for the case of income and expenditure approaches o
lt does not include the effects of illegal activities
Simple Circular FIow of Income
The simple circular flow of income describes how incomes in a two secror economv flow between
households and firms
Each time an item is produced and sold, it is observed that its value is equal to the consumer's expenditure
(Expenditure Approach). The same amount of expenditure is received as income by various people who
contributed to its production (I ncome approach). And the same value of expenditure is as a result of value
added at various stages of production (value added or product approach). Therefore, the expenditure,
income and out put approaches are supposed to give identical results when estimating the level of national
income. That is E = Y = O
Assumptions of the circular flow of income
There are only two sectors in the economy that is the householcls sector (consumers) and business sector
(producers)
There are no leakages and injections in the economy, .
Households are the only owners and suppliers of factors of production. .

126 | P a g e
All the income received by households is used to buy goods and services.
Firms (business enterprises) are the only producers of goods and services. .
All output produced by firms is sold in the market .
There is full employment of factors of production

From the figure above, frims demand fornfactors of production (A) supplied by households (H) through
the factor market. In return , the households earn income from the supply of factors of production (G)
which is equivalent to the costs of factors of production by firms (B).
Firms use factors of production to produce goods and services (C) which are demanded by households (F)
through the product market . in return firms earn revenue from the sale of goods and services (D) which
is equivalent to consumption expenditure by households (E).

IMPRORTANCE OF MEASURING NATIONAL INCOME STATISCTICS

National policy analysis. National income data forms the basis of national policies such as employement
policy. The figures enable the government to determine the direction in which the industrial out put,
investments and saving change such that proper measures can be adopted to match the population growth
and economic growth.
National development planning and budgeting. National income figures are important in economic
development planning. It is essential that data concerning out put, savings and consumption is made
available if planning and budgeting is to be effective.
Research purposes. National income statisctics are used by reaserchers in the area of economics and other
scholars to carry out research. They make use of data about the country’s output, incomes and expenditures

127 | P a g e
obtained from national income accounts to determine and predict relationships between economic
variables.
Determination of standards of living. National income figures/data is uded in measuring the country’s per
capita income which is a good indicator of the economic welfare of the people.
Determination of the nature of income distribution. National income statisctis are used to show how
income is distributed among sectors and regions of the economy. From the data relating to wages, rent,
interest and profits, the disparities in the incomes among different regions and groups of people in society
are determined. This enables the government to come up with corrective measures to reduce the income
inequalities.
International comparisons. National income figures are used to compare the growth rates of different
sectors, regions and countries.
National income figures are used to sftorv the contribution made by different sectors of the economy to
development especially when the out put method is used. This helps to identify which sectors are lagging
behind such that appropriate policies are designed to improve on their performance.
National income figures are used to show economy. The increase in national income natural resources in
the econonty. They show the patterns of expenditure by the private sector and the government.This is
shown by figures of private expenditure which is important in making the
National budget where there is need to balance between private and public expenditures.
National income figures are used to attract foreign investment in the country. National income figures are
an indicator to the out side world about the performance of the economy. High and increasing national
income figures encourage foreigners to invest in the economy.
National income figures are used to solicit for foreign afd. Donor countries and other financial
organizations base on national income figures to give foreign aid.

Problems involved in Calculating (Estimating) National income

 Inadequate accurate and reliable statistical data, There is always inadequate information due
to limited facilities like computers and lack of proper record keeping by producers and consumers.
 Double counting. This refers to counting of the value of the item more than once when estimating
national income, It is as a result of failure to distinguish properly between the final goods and
intermediate goods.

128 | P a g e
  It also occurs when government gifts and pension which should be excluded as transfer payments
are included in national income figures. This leads to over estimation of national income figures.
 Difficulty in determining the boundary of production, This is concerned with which items
should be included or excluded when estimating national income. This is pa.rticularly a problem
due to failure to define some services for example whether child labour or the services of a house
wife should be included or exiluded from the estimation of national income.
 Price changes (inflation).This is a problem because price changes affect the value of national
income. When there is inflation, national income shows an increase yet the real production of
goods and services might have reduced hence over estimation of national income.
 it is difficult to measure depreciation. This makes it difficult to determine the net income because
firms use different methods of measuring depreciation.
 Problem of non- marketed activities.lt is difficult to estimate the monetary value of goods and
services which are not put in market. Such values have to be imputed for inclusion in the national
income estimation. For example services of a housewife, owner occupied houses, leisure forgone
when income is earned ans subsistence output.
 Poor social and economic infrastructure. For example inaccessible roads, poor communication
networks and limited banking facilities limit national income estimation exercise.
 Omitted market transcations. In an economy, a large number of transactions take place in the
market but not all are included in estimating national income. Omission of transactions leads to
under estimation of national income figures.
 Inadequate skilled and qualified personel. There is limited numbers of stasticians, economists
and accountants required to collect, compute , analyse and interpret national income figures.
 It is difficult to measure Net Income from abroad. This is difficult to determine since imports
and exports are carried out by many individuals with little data available to verify the amount
imported and exported by private firms and individuas. At times it is difficult to identify the
smuggled commodities.
 Problem of timing of production. It is very difficult to determine output produced in the country
during a particular year. This is true especially for agricultural output in which it becomes difficult
to consider the time of production or the time of harvesting when estimating national income.
 It is difficult to determine the actual value of public utilities. This is because the are usually
subsidized by the government.

129 | P a g e
  It is difficult to identify inventories due to overlapping seasons.
 It is difficult to identify incomes fro illegal activities such as smuggling, gambiling prostitution
etc. such incomes are not supposed to be included when estimating national income.
 Inadequate facilities and equipments used to collect, analyse and estimate data. For example
there is shortage of funds and computers required to carryout the exercise successfully.
 Political instabilities and insecurity in some parts of the country. This makes it difficult to access
some parts of the countryto collect data for purposes of estimating national income.

Per capita income and standards of living.

Per capita income refers to the average income of individuals of a country in a particular year.

Per capita income =

Standard of living refers to the level of economic welfare enjoyed by a person, family or nation which is
achieved by consuming a variety of goods and services, including leisure, security, accommodation,
employement, freedom, self esteem and human rights.
Cost of living, This refers to the amount of money required to buy goods and services to sustain a given
standard of living.
Since income per capita shows the volume of goods and services available to a individual in a given period
usually one year. It is often used to measure the standards of living of citizens in a particular counry . lt is
also used to compare standards of living between countries .However, there are many limitations in using
per capita income to measure the standards of Iiving in a given country.

Limitations of using Per capita Incame in Measuring standards of Living

 Per capita income daes not reveal the nature of distribution of income. Per capita income figures
may be high when there is high degree of income inequality in the economy. The high income
figures may be as a result few rich individuals yet the majority of the population is poor.
 The high per capita income may be as a result of increase in prices of goods and services in the
country due to inflation. This rnay not necessariiy show improvement in standards of living.
 Per capita income does not consider the amount of letsure available to citizens in the country. Out
put may increase as the result of over working labour which does not reflect a high standard of
living.

130 | P a g e
  Per capita income does not show the degree of freedom, security and self esteem enjoyed by the
citizens. Per capita income figures may be high when the majority of the population have no
freedom and have low esteem.
 Per capita income does not reflect the level of unemployment in the country.The per capita figures
may be high as a result of using capital intensive techniques of production yet the majority of the
people have no jobs.
 The county's per capita income may increase as a result of producing capital gaods at the expense
of consumer goods which do not improve direcily the stJndaids of living of the citizens.
 Per capita income does not show the quality of goods produced in the economy. The per capita
income figures may be high yet the quality of the products produced in the country is poor.
 Per capita income does not consider other factors which contribute to the standards of livtng. For
example per capita inccme may increase when there is high level of pollution, accidents and
politicalwars in the.ouniry.
 Per capita income may increase as a result of underestimating population figures. This does not
necessarily imply high standards of living.
 Per capita income may be low due to the presence of a large subsistence sector. Output from the
subsistence sector may not be included when estimating national lncome yet goods and services
produced under this sector contribute to the welfare of the people.

Limitations of using per capita income in comparing standards of living between countries.
 Differences in income distribution. Per capita income does not show tha nature of income
distribution btween countries. A country may be having a high level per capita income yet there
exists high levels of income inequalities.
 Differences in the quality and composition of goods and services consumed in the different
countries. A country may be having high per capita income when the economy is concentrating on
the production of capital goods which do not directly contribute to the welfare of the people.
 Differences in the accuracy and tools used to estimate population and national income figures.
The country’s high per capita figures may be as a result of underestimating the population figures
and over estimating national income figures and this may not necessarily reflect better standards
of living.

131 | P a g e
  Differences in the levels of inflation (prices). The per capita income may be high when the
general price level of goods and services is high. This does not necessarily imply high standards
of living but high costs of living in the country.
 Differences in the size of the subsistence sector. Per capita income figures may be low due to
presence of a large subsistence sector in the country. This is because it is difficult to include
subsistence output when measuring national income. This does not imply low standards of living.
 Differences in production and transport costs. Per capita income may be high when the country
is experiencing high production and transport costs. This does not imply better standards of living.
 Differences in the amount of leasure enjoyed in the two countries. The country may be having
high per capita income figures at the expense of leisure. This leads to low standards of living.
 Differences in non material benefits enjoyed by the people, for example freedom of expression
and self esteem which is not reflected in the per capita income. The per capita income figures may
be high when citizens are not allowed to freelt expess themselves.
 Differences in the availability of social services like education , health and communication
services. The country’s per capita income figures may be high when social facilities are either of
poor quality or inadequate. This does not imply better standards of living.
 Differnces in the level of employement. Per capita income figures may be high when there are
more unemployed people inone country as compared to the other.
 Differences in tastes and preferences. The per capita income may be high when goods and
services produced do not meet the tastes and prefences of the consumers.
 Differences in the boundary of production. The per capita income of the country may be high
between certain items are included in the calculation of national income and yet they are excluded
from another country. This does not imply low standards of living in the country where they are
excluded for example incomes from gambling and prostitution.
 Differences in currencies. Countries use different currencies and therefore their per capita income
figures appear in different values. A country may be having high per capita income figures when
the exchange rate value of its curreniy low in another country, This does not imply high standards
of living,
 Differences in the methods used to measure national income.The per capita income figures
may be high when the country uses the expenditure approach insiead of the output approach' The

132 | P a g e
 high expenditures may be as a result ot ttre high prices of goods and services which does not reflect
high standards of living.
 Differences in political climate between countries. The per capita income figures may be high
when the country is experiencing political insiabilitibs especially when the country uses the
expenditure approach of measuring national income. This does not imply better standards of living

INCOME DISTRIBUTION
Income distribution refers to the extent to which various social economic groups are able to access incomes
in a given country. This is reflected in the invesiment and consumption patterns.
Income inequality (disparity) refers to the econonric gap between the rich and the poor within the same
country. The income disparities can be illustrated by the use of a Lorenz curve.The Lorenz curve shows
the relationship between the population and its relative income share

The diagonal line AO (line of perfect equality) in the figure above shows that any point on the diagonal,
any income received is exactly equal to the percentage oi the population that receives it. Therefore the
diagonal line represents perfect equality in the distribution of national income.
However, in reality perfect equality does not exist even in socialist economies. This illustrated by the
Lorenz curve which shows the actual income distribution between the percentage receipients and the
percentage of the total income they receive in a given time.
The more the Lorenz curve lies away from the line of perfect equality line, the greater the degree of income
inequality.
The Gini- coefficient

133 | P a g e
This is obtained by calculating by calculating the ratio of the area between the line perfect equality and
the Lorenz curve as compared to the total area of the part of the square in which the Lorenz curve lies.
In the figure above, the gini coefficient is the ratio of the shaded area to the total area of the triangle AOB.

ℎ ℎ
− =

The gini-coefficient varies from zero to one. Income inequality increases as the coefficient tends to one.

Causes of income inequality

 Uneven distribution of natural resources. People in regions which are endowed with natural
resources like minrals, fertile soils, good climate etc accumulate more wealth than those in areas
without such natural resources.
 Uneven distribution of industries between urban and rural areas. This arises due to the
concentration of industries in urban centres and other infrasturtures which leads to imbalances in
income generating activities in favour of urban areas hence income inequalities.
 Differences in family background. People from rich families have a higher chances of inheriting
wealth and use family influence to get better paying jobs as compared to their counterparts from
poor families.
 Differences in the levels of education and training. People with higher level of education and
training earn higher incomes as compared to to individuals with low education levels and training.
 Differences in natural talents and abilities. People with special talents like the muscians,
footballers and those who are creative and innovative accumulate more wealth than their
counterparts without talents.
 Differences in political climate. People living in politically stable areas have the ability to invest
and accumulate more wealth as compared to their counterparts in politically unstable areas.
 Differences in stock of wealth. Wealth creates more wealth. People with a large stock of wealth
have high chances of investing and acquiring more wealth than people with little wealth.
 Differences in age.The old aged people tend to have more wealth and income than the young
because they have accumulated property over time.

134 | P a g e
  Differences in the side effects of inflation on fixed income earners and business people. Fixed
income earners loose out during inflation and this leads to a fall in the reai income. On the other
hand business people gain much from inflation and they end up accumulating more income.
 The differences in luck. Lucky peopie have chances of becoming rich more easily than the
unlucky ones especially through lotteries.
 Differences in government policy. The governrnent can deliberately plan to develop certain
regions and sectors faster as cornpared to other areas and sectors. This creates income differences
among peopie in different regions and sectors.
Advantages (Merits) af income inequality
 Generates revenue to the gavernment. The rich are taxed more than the poor thruogh progressive
taxation and this enables the government to raise more tax revenue,
 It encorages the poor and the lazy ones to work hard. Due to income inequalities, the poor are
compelled to work hard so as to catch with their rich counterparts
 Income inequalities promote investments in the country, This is because the very rich have a high
propensity of saving part of their incomes which they can invest .This lncreases employment
opportunities and the level of out put hence economic growth and development
 lt encourages better working relations rvhere the employers and the workers. This is because the
poor empioyees have respect for their rich employers,
 High incomes earned by the professianals encourage them to work hard within the country. This
reduces on the danger of brain drain
 It encaurqges geographical labour mobility, This is because individuals move from one place to
another in search for better opportunities

Disadvantages (Demerits) of tncome inequaliry

 It leads to the production and importatian of luxurious goods demnnded by the rich. This under
mines the production of the basic goods and services required by the majority poor.
 It treads to rural urban migration. The high incomes earned by people living in urbart areas attract
people to move from rural areas to towns, This leads to congestion and increased crime rates in
towns.
 It increases government expenditure to support the maiority poor in form of sociai services like
education and medical care.

135 | P a g e
  It increases social tension in society. This is in form of robbery, child sacrifice and high crime rates
especially among the poor. At this is done with the intention of becoming rich.
 It leads to social ond economic conflicts between regions. this can develop into political
instabilities hence breakdown of economic activilies.
 It encourages ill feeling and apathy by the poor for the rich. This results into witchcraft which
undermines healthy competition, growth and development.
 It leads to low levels of consumption and eff'ective aggregate demand in the economy. This is true
when the majority of the people are poor. This reduces investment and economic growth in the
economy.
 It leads to balance of payment problems. This is as a result of increased importation of goods and
services which increase import expenditure while export earnings decline or remain fixed.
 It leads to profit repatriation especially when the rich are foreigners. This leads to low levels of
development in the economy.
 It leads to exploitation of the poor by the rich. The rich employers pay low wages to the poor
employees. In addition the rich monopolies exploit the poor by restricting output and charging
high prices for goods and services.
 It leads to poor standards of living for the poor. This is because the poor can not afford the bascis
needs of life like food, shelter, medical care, clothing.
 It reduces government revenue. This is because the majority of the people are poor and can not be
highly taxed to generate more tax revenue.
 It leads to underdevelopment of social and economic infrastructure for example roads, banks and
other communication facilities. This is because the poor can not effectively and optimally use such
facilities.
Policy Measures To Reduce Income Inequalities.
 Price stabilization and control measures. These are aimed at reducing price fluctuations
especially for agricultural commodities so as to stabilize the income of the farmers. The
minimum price legislation for agricultural products helps to increase rural incomes for peasants
in order to minimize rural-urban income disparities.
 Minimum wage policy. Employees are not supposed to be paid a wage below one set by the
government. This is aimed at reducing the income gap between wage earners. There is also need

136 | P a g e
 to constantly revise the minimum wage set in order to match with the prices changes in the
economy.
 Population control measures. This is aimed at reducing the high dependence burdens and the
diminishing returns in agriculture. The reduction in dependence burdens help individuals to
increase their marginal propensity to save and per capita incomes hence increase in investments.
 Decentalisation of regions and delocalization of industries in all areas in the country. This is
aimed at improving service delivery for the people and to give equal employement opportunities
to both people in the rural and urban areas. This leads to equitable distribution of income
between regions.
 Use of fiscal policies in form of manipulating government expenditure and taxation. There
is need to carry out progressive taxation as a way of reducing income inequalities between the
rich and the poor. The rich should be made to pay more income tax and the tax revenue is then
used to provide social services to the poor. In addition, there is need for the government to
increase its expenditure on essential projects which directly benefit the poor as a way of
improving their standards of living.
 Rural development policies. Such policies include developing cottage industries,modernizing
agriculture, rural electrification programmes and improvement of social and economic
infrastructures in the rural areas. All this is aimed at minimizing rural-urban imbalances.
 Education reform policy.There is need to change the education system so as to train job creators
instead of joh seekers. Educational programrnes should provide relevant training and practical
skills required in the job market. Such skills include vocational training in the fields of tailoring,
entrepreneurship skills, carpentry etc. ln addition, there is need for the government to provide free
education especially to the children of the poor as a way of reducing income inequalities
 Land reform policy. This is concerned with changing the structure of land use and ownership
(land tenure system). Such policies include land consolidation, land reclamation, land registration
as well as resettlement schemes. All this is aimed at increasing agricultural productivity and
reducing income inequality between the landlords and the tenants.
 Investment policy. There is need to attract both local and foreign investors to set up industries by
providing a conducive investment climate especially in rural areas. This helps to create more
employment opportunities and incomes for the masses.

137 | P a g e
  Provision of the credit facilities especially to the poor. Credit in form of soft loans can be used
by the poor to finance income generating projects. This leads to the breakclown of the vicious
circle of poverry hence reducing income inequalities among the peopie. For example prosperity
for all funds.
 Promoting political stability through democratic gavernance. This is aimed promoting
investments in all regions in the country as a way of ensuring equitable distribution of incornes
and resources.
 Market expansion. There is need to widen the domestic and foreign markets for the locally
produced goods. Efforts should be geared towards improving the quality of the locally produced
goods through value addition, market research and economic integration. This promotes trade
hence increasing the incomes of the people
 Proper resource allocatian and management. There is need to ensure proper accountability and
transparency in allocating and managing public funds. This helps to reduce corruption and
embezzlement of government funds meant for development especially in rural areas.
 Construction of social and Econamtc infrastructure. Infrastructure in form of roads, schools,
hospitals and banks form the engine of growth. Such infrastructure helps people to improve on
their standards of living hence reducing income inequalities,
 Liberalizatian of the economy. There is need to encourage all the people to freely participate in
economic activities as a way of boosting their incomes and reducing income inequalities.

138 | P a g e
CONSUMPTION, SAVINGS AND INVESTMENT
CONSUMPTION THEORY
Cosumption refers to the act of using final goods and services to satisfy human needs.
Consumption = Disposable income -savings.
Concepts used in Consumption theory
Autonomous consumption. This is consumption that is independent of the level of income. That is, it is
income inelastic.
Induced consumption. This is consumption which depends on the level of income. An increase in income
leads to an increase in consumption and vice versa.
Marginal Propensity to Consume (MPC).This refers to the proportion (fraction) of the additional
income that is consumed. lt is expressed as the ratio of a change in consumption to a change in income.
∆
=
∆
The marginal propensity to consume tends to reduce with increase in income ie it is high among the low
income earners and low among the rich.
Average Propensity to Consunte (APC). This refers to the fraction of total income that is consumed. lt
is the ratio of total consurnption expenditure to total income.

Marginal propensity to import (MPI).This refers to the fraction (proportion) of additional national
income spent on the imports of the country. It is expressed as the ratio of a change in import expenditure
to a change in national income.
ℎ
=
ℎ
Average propensity to irnport (APM).This refers to the fraction of total national income that is spent
on imports. It is expressed as ratio of total expenditure on imports to total national income.

Determinants of (Factors influencing) Consumption

Level of dispasable Incorne.The higher the level of'disposable income, the higher the level of
consumption and the lower the level of disposable income, the lower the level consumption.

139 | P a g e
The level of saving. The higher the level of savings the lower the level of consumption and the lower the
level of savings, the higher the level of consumption.
The level of wages. An increase in the wage rate leads to an increase in consumption and a reduction in
the wage level leads to a fall in the level of consurnption.
Level of direct taxation. An increase in current taxes reduces the disposable incomes of people hence a
reduction in consrrmption. Butt a reduction in direct taxes increases disposable incomes of people hence
an incrcase in consumption.
Level of government expenditure.lncrease in government expcndrture for example of transfer payments
leads to an increase in consumption and a reduction in governmeni expenditure reduces consumption.
Rate of interest on cleprssifs, An inclc:rse consumption anrl a clccrcasc in interest consumption.
Level of liquidity preference. The higher the level of liquidity preference, the lower the level of
consumption and the lower the level of liquidity preference, the Iower the level of liquidity preference
the higher the level of consumption.
Consumer's expectations. If the consumer expects inflation in future, current consumption increases and
if a consumer expects a fall in prices in future, current consumption reduces.
Nature of income distribution. Consumption is low where there is high level of income inequalities. But
with fair income distribrition, consumption increases.
Cost and availability of credit. Availability of credit facilities in form of hire purchases, cash discounts
etc increase consunlption and absence of such credit facilities reduce the level of consumption,
Size of the population .An increase in population leads to increase in the level of consumption but a fall
in population leads to a reduction in the level of consumption.
Level of Inflation in the economy. An increase in the general price level reduces the real value of money
hence a fall in consumption, But a decrease in the general price jevel increases the real value of money
which leads to an increase in income
Level of retained profits. The more profits the company retains in business the lower :ne level of
consumption while the lower the amount of retained profits the higher the levei of consumption.

SAVINGS
Savings refer to the part of disposable income that is not spent on the current consumption of goods and
services.
Dissaving refers to negative savings. It occurs when consumption is greater than disposable income.

140 | P a g e
Concepts used under the Savings theory
Contractual savings. These are savings where an individual is supposed to save a fixed amount of rnoney
in a given time for exampie per month. They include savings with insurance companies, pension schemes
etc.
Discretional savings. This is where people are not obliged to save a specific amount in a siven time for
exampie bank deposits, building societies etc.
Marginal propensity to save (MPS). This is the proportion (fraction) of the additional income that is
saved. It is expressed as the ratio of change in savings to the change in .:tcome.
∆
=
∆
Average propensity to save (APS) refers to the proportion (fraction) of the total income which is saved.
It is expressed as the ratio of total savings to total income.

Determinants of the Level of Savings in the Economy

Rate of interest on bank deposits. The higher the interest rate, the higher the level of saving and the
lower the interest rate the lower the level of savings.
The level of income. The higher the level of income, the higher the level of savings and the lower the
level of income the lower the level of svings.
The rate of inflotian. The higher the rate of inflation, the lower the level of savings. This is because with
a general increase in the price level, the real money value reduces hence discouraging people from saving
their money in cash form.
Age of an individual, people tend to save and dissave at different times of their life cycle. Young people
tend to save less while relatively older people tend to save for their retirement at old age.
Degree af occurrence of unforeseen circumstances. Most people put some money aside, if they can,
when they expcet things like wife's delivery, sickness, unemployment etc.
Habits and customs. Sonrc people ancl societies have a higher saving culture than others for exantple
members belonging to a saving association are more likely to save than those ones who do not belong to
any saving association,

141 | P a g e
Health status of the person, ill health ciiscourages savings, this is because a sickly person who is
expectrng death in the near future will only consume all that he/she has instead of saving

THE INVESTMENT THEORY

Investment refers to thc proccss of devoting part of national income to create capital goods
OR lnvestmcnt refers to thc act of purchasing capital goods and establishing capital assets with the aim of
increasrng on the level of capital stock in the economy.
Net investment. This refeers to the total amount of total capital invested minus depreciation (capital
consumption allowance)
Real investment. This refers to the addition to the stock of capital assets which leads to the increase in
the level of income and production.
Financial investment. This refers to the purchase of existing capital assests and this implies there is no
net addition to the nation’s stock of capital.
Gross investment. This refers to investment during a given period of time without making allowance for
depreciation of the existing stock of capital.

Types of lnvestment
Autonomus investment. This is the form of investment which is independent of the level of income. It is
influenced by other factors such as innovatios, growth of labourforce, social and legal institutions etc.
examples include government expenditure on roads, schools hospitls etc
Induced investments, This is the form of investment which depends on the level of income and profits.
It is influenced by factors such as interest rates, availability of market wages etc. The higher the level of
income, the higher the level of induced investrnent and the lower the level of income, the lower the level
of induced investment.
Determinants of the level of investment in the Economy
Level of income. High levels of income leads to high levels of investment because it encourages savings
which increase the amount of funds available for borrowing by investors to be used in the establishment
of new firms or expanding the existing ones. Low levels of income leads to low investments as it
discourages savings which limits the amount of funds available for borrowing by investors to establish
new firms.

142 | P a g e
The interest rate on loans or capital . Low rates on interest on capital or loans leads to high levels of
investment because investors are encouraged to borrow for investment of new projects and expand the
existing ones. On the other hand, an increase in the interest rate reduces the level of investment in the
economy.
The marginal efftciency of capital. This refers to the ratio of the expected monetary returns from an
additional unit of capital asset invested to its supply price.The higher the marginal efficiency of capital,
the higher the level of investment and the lower the marginal efficiency of capital, the lower the level of
investment.
Level of technology. Improvement in the level of technology through inventions and innovations leads
to more efficient methods of production which increases the marginal efficiency of capital hence an
increase in investments. On the other hand, use of poor technology discourages investments in the
economy.
The level of existing capital stock. The higher the level of the existing stock of capital the higher the
level of investment because it increases the capacity of producers to hire factors of production to be used
for the establishment of new firms and expansion of the existing ones. The lower the level of the existing
capital stock, the Iower the level of investment.
Government policy of taxation and subsidization. lf the government policy is favorable in form of
providing subsidies and other credit facilities to the investors, induced investment increases. But in case
the government policy is unfavorable in form of high taxes, and other bureaucratic processes, investment
is discouraged.
Political climate. Existence of political stability in the economy encourages investment because investors
are assured of security of their lives and property which encourages them to establish new projetcs and
expand the existing ones. But if there is political instabiliry both domestic and foreign investors are
discouraged which leads to a decline in investments.
The nature of social and economic infrastructure, Existence of better social and economic
infrastructure in form of good road network, communication services, banking facilities encourages
investments in the economy because it reduces production costs and increases producer’s profit. But poor
social and economic infrastructure discourages investment in the economy.
Nature of entrepreneur abilities ,High level of entrepreneurial skills increase investment because they
are able to moblise factors of production for the establishment of new investments and low entrepreneurial

143 | P a g e
skills in the economy discourage investments because they are unable to effectively moblise the factors
of production which limit establishment of new investments.
Size of the market. Big size of the market leads to high levels of investment because it encourages
investors to produce more to increase their profits but small size of the market leads to low levels of
investment because investors are discouraged to invest due to fear of excess output that will lead to heavy
losses.
Population growth rate. Low population growth rate leads to high levels of investment because it leads
to reduced consumption and inceases savings, which increases the amount of funds that are available for
investors to borrow but high population growth rate leads tom low levels of investment because it leads
to increased consumption and reduced savings, which limit the amount of funds available for investors to
borrow.
Rate of inflation. Low rate of inflation leads to high levels of investment because they reduce production
costs and also reduce prices for the final products, which encourages demand consequently inceasing the
profits of producers and encourage them to invest. On the other hand, high rates of inflation increases
production costs and also increases prices of the final products, which limits demand, consequently
limiting profits of the producers hence discouraging investment.
Level of savings. High level of savings increases the amount of funds available for borrowing by investors
to be used in the purchase of factor inputs for the establishment of new firms and expansion of the existing
ones leading to high levels of investment and vice versa
Level of capital outflow.
Level of accountablility.

Factors That Limit The Level Of Investment In An Economy

High population growth rate
Low levels of income
High rate of interest on capital
Low levels of savings
Etc

Measures To Increase The Level Of Investment

144 | P a g e