To judge how an economy is doing, you need one number for how much it produces and earns. National income accounting provides it. Governments use it to plan and tax, investors to size markets, and international bodies to decide what each member pays.
The Institute of Chartered Accountants of Nigeria (ICAN) syllabus asks for the basic concepts, the three methods of computing national income, the problems of measuring it and its uses.
It is also a numerical topic. Be ready to calculate gross domestic product (GDP), GNP and national income from a list of figures, and to explain why nominal and real values differ.
In 30 seconds
National income is what an economy’s output of goods and services is worth in money terms over a period, usually a year. GDP counts what is produced inside the country, whoever owns the producer. GNP counts what the country’s own citizens produce, at home or abroad. Net national product is GNP less depreciation.
There are three ways to measure it, the output, income and expenditure methods, and they should give the same answer. The main problems are double counting, goods that are not traded, depreciation, poor data, changing prices and illegal income.
Basic concepts
| Term | Meaning |
|---|---|
| National income | The money value of the flow of goods and services produced in an economy over a period. In the strict sense, it is the total income earned by the factors of production, valued at factor cost |
| Gross domestic product (GDP) | The money value of all final goods and services produced inside a country in a year, including output by foreign-owned firms based there |
| Nominal GDP | GDP at current prices. It counts only output sold in a market, values output in its final form, and rises when prices rise |
| Real GDP | GDP at constant prices. It removes the effect of price changes, so it shows changes in actual output |
| Potential GDP | The most the economy can produce without pushing up the general price level |
| Gross national product (GNP) | The market value of final goods and services produced by a country’s citizens, whether at home or abroad |
| Net national product (NNP) | GNP less depreciation (the capital consumption allowance) |
| Net property income (NPI) | Income that nationals earn from assets abroad, less the income that foreigners earn from assets in the country |
How the measures link
GDP at factor cost = GDP at market prices − indirect taxes + subsidies
GNP = GDP ± net property income
NNP = GNP − depreciation
National income = net national product at factor cost
The syllabus gives an example. A foreign-owned oil company operating in Nigeria adds to Nigeria’s GDP. But part of its profit is sent to its owners abroad, so that part counts in the owners’ country’s GNP and reduces Nigeria’s GNP below its GDP.
The three methods of computing national income
The output (product) method
Add the value of all final goods and services produced in the economy in the period, or the value added at each stage of production. Start with GDP at market prices, convert to factor cost by subtracting indirect taxes and adding subsidies, adjust for net property income to reach GNP, and deduct depreciation to reach net national product.
The income method
Add the incomes earned by the factors of production for producing goods and services in the period: wages, salaries and commissions before tax and deductions, rent and royalties, interest and dividends, and profits of public and private enterprises. Transfer payments, such as state pensions or gifts between individuals, are excluded because they are not earned from production. The total is gross domestic income at factor cost.
Adjusting for net property income gives gross national income, and deducting depreciation gives net national income.
The expenditure method
Add all final spending on the economy’s output at market prices.
GDP = C + I + G + (X − M)
- C: household consumption spending, on durable and non-durable goods and services.
- I: investment spending by firms on plant, machinery, construction and changes in stocks.
- G: government purchases of final goods and services. Transfer payments are excluded because they do not reflect current production.
- X − M: net exports, which is exports less imports.
Total domestic expenditure (TDE = C + I + G) counts all spending in the country, including spending on imports. To reach spending on domestic output, add exports and deduct imports. The result is gross domestic expenditure, which equals GDP. Convert it to factor cost by adding subsidies and deducting indirect taxes. Adjusting for net property income and deducting depreciation gives net national expenditure, which is national income.
The circular flow of income
The circular flow shows why the three methods agree. Households supply factor services to firms and receive factor incomes. Firms supply goods and services and receive consumer spending. National income can therefore be measured as output, as income or as expenditure.
The basic identity is national product = national expenditure = national income. National accounts record what actually happened, which is the ex-post figure, and not what people hoped or planned, the ex-ante figure.
Worked example: from expenditure to national income
Scenario. An economy has these figures in ₦ billion: household consumption 8,000; investment 2,500; government spending 3,000; exports 1,800; imports 1,500; indirect taxes 900; subsidies 200; net property income −400 (more income flows out than in); depreciation 700. The population is 120 million. Calculate GDP at market prices, GDP at factor cost, GNP at factor cost, national income and income per head.
| Step | Working | ₦ billion |
|---|---|---|
| GDP at market prices | 8,000 + 2,500 + 3,000 + (1,800 − 1,500) | 13,800 |
| GDP at factor cost | 13,800 − 900 + 200 | 13,100 |
| GNP at factor cost | 13,100 + (−400) | 12,700 |
| National income (NNP at factor cost) | 12,700 − 700 | 12,000 |
Income per head is ₦12,000 billion ÷ 120 million people, which is ₦100,000 a person a year.
Nominal and real GDP
Suppose nominal GDP rises from ₦13,800 billion in year 1 to ₦16,100 billion in year 2, and the price index rises from 100 to 120. Nominal GDP is up by 16.7% (16,100 ÷ 13,800). Real GDP in year 2 is 16,100 ÷ 1.20 = ₦13,417 billion, which is 2.8% lower than year 1. Output has fallen even though the nominal figure rose, because prices rose faster than the money value of output.
Problems of measuring national income
| Problem | Explanation | How it is handled |
|---|---|---|
| Double counting | Counting intermediate goods or transfer payments as well as final output inflates the total | Count only final goods or value added, and leave out transfer payments |
| Goods that are not marketed | Output that is not sold, such as food grown and eaten on the farm, is hard to value | Some is included at an imputed value, such as rent on owner-occupied homes. Unpaid housework is left out |
| Depreciation | Capital wears out, but the true amount is hard to measure, and any error distorts the net figure | Estimates of the capital consumption allowance |
| Inadequate data | Individuals, firms and agencies often keep poor records, especially in developing countries | Use the method for which good data exists. Some countries cannot use the income method |
| Price level changes | Money changes in value, so comparisons over time are unreliable | Express national income in real terms, at constant prices |
| Illegal activity | Only legal income is recorded, though some illegal income may slip in | It is a practical problem for the accountants who compile the figures |
An example of double counting
A farmer sells wheat to a miller for ₦100. The miller sells flour to a baker for ₦180. The baker sells bread to consumers for ₦300. Adding all the sales gives ₦580, which overstates output. Only the final value of ₦300 counts. The same total comes from adding the value added at each stage: farmer ₦100, miller ₦80 (180 − 100) and baker ₦120 (300 − 180), which is ₦300.
Uses of national income estimates
- An index of economic welfare. Real income per head is a rough measure of a nation’s well-being.
- Economic planning. Estimates show the potential rate of saving, investment and growth, and the starting point for plans.
- Understanding the structure of the economy. The output method shows the part each sector plays. The expenditure method shows how much is consumed, invested or sent abroad. The income method shows how income is distributed, which helps income tax policy.
- Estimating demand. Investors use income per head to judge how much people will buy.
- Fixing contributions that a country pays to international bodies such as the United Nations (UN), Economic Community of West African States (ECOWAS) and the IMF.
- Comparisons. Real income per head compares living standards between countries, which is an international comparison, and between years, which is an intertemporal comparison, including before and after a plan.
National income in more detail
The circular flow: injections and leakages
Households spend income on goods, and firms pay incomes to households. Some income leaks out of the flow: savings, taxes and spending on imports. Some spending is injected back: investment, government spending and exports. When injections equal leakages, national income is steady. If injections exceed leakages, income rises. If leakages exceed injections, it falls. This is why the expenditure approach includes investment, government spending and net exports.
Value added: avoiding double counting
In the output method, count only the value added at each stage, the value of a firm’s output less the cost of materials it bought from others. In the wheat, flour and bread example, the farmer adds ₦100, the miller ₦80 and the baker ₦120. The total value added of ₦300 equals the final value of the bread.
Real and nominal GDP: the deflator
Dividing nominal GDP by a price index and multiplying by 100 gives real GDP. If nominal GDP is ₦16,100 billion and the price index is 120, real GDP is 16,100 ÷ 1.20 = ₦13,417 billion. Equally, the GDP deflator is nominal GDP divided by real GDP times 100. If real GDP was ₦13,800 billion in the base year at a price index of 100, growth in real terms is (13,417 − 13,800) ÷ 13,800 = −2.8%, a fall, even though nominal GDP rose.
Limits of GDP as a measure of well-being
- Non-marketed output. Unpaid household work and subsistence farming are largely missed.
- The informal economy. Unrecorded activity is excluded, which matters a great deal in developing countries.
- Distribution. An average hides inequality. A rise in GDP per head may benefit only a few.
- Quality of life. GDP does not count health, education, leisure, safety or the environment, and it counts the cost of pollution clean-up as output.
- Quality and variety of goods, which are hard to measure over time.
- Illegal activity. It is not recorded.
Uses of national income figures
Governments use them to plan, to judge the stage of the business cycle and to set tax and spending policy. Businesses use them to forecast demand. International bodies use them to compare countries and to set contributions. Researchers use them to track growth over time, ideally in real, per head terms.
Exam focus: the three methods and the key formulas
The syllabus gives three ways of computing national income. Use whichever suits the data available. All should give the same total.
- Product (output) method. Add the values of all final goods and services produced inside the country in a year to get GDP at market prices. GDP at factor cost = GDP − indirect taxes + subsidies. GNP = GDP ± net property income (NPI). NPI is the difference between earnings of foreign-owned assets in the country that flow out and earnings of the country’s assets abroad that flow in. The syllabus’s example is a foreign-owned oil company, whose output counts in Nigeria’s GDP but whose profit sent abroad counts in the foreign country’s GNP. NNP = GNP − depreciation (capital consumption allowance).
- Income method. Add the factor incomes earned in producing output: wages and salaries before tax, rent and royalties, interest and dividends, and profits. Leave out transfer payments such as state pensions. This gives gross domestic income at factor cost (GDYf). GNYf = GDYf ± NPI. National income is GNYf less depreciation.
- Expenditure method. Add all final purchases at market prices: GDP = C + I + G + (X − M). C is household consumption of durable and non-durable goods and services. I is capital investment, including plant, machinery, construction and changes in inventory. G is government purchases of final goods and services. X − M is exports less imports.
Three measures of GDP appear in the text: nominal GDP (current prices), real GDP (constant prices) and potential GDP (the maximum output the economy can produce without raising the price level). Only output traded in a market counts, so do-it-yourself services such as washing your own clothes are excluded.
Common mistakes in the exam
- Mixing up GDP and GNP. GDP is by location. GNP is by ownership.
- Including transfer payments in the income or expenditure method.
- Forgetting to convert from market prices to factor cost, or adding indirect taxes when you should subtract them.
- Taking imports as an addition. They are deducted, as in X − M.
- Comparing nominal figures across years and calling it growth.
- Counting total sales and not value added.
Quick revision
- GDP by place of production. GNP = GDP ± net property income. NNP = GNP − depreciation.
- GDP at factor cost = GDP at market prices − indirect taxes + subsidies.
- Methods: output, income, expenditure. GDP = C + I + G + (X − M).
- Exclude transfer payments. Count final goods or value added only.
- Real GDP is at constant prices. Use it to compare years.
- Problems: double counting, non-marketed goods, depreciation, poor data, price changes, illegal income.
- Uses: welfare, planning, structure of the economy, demand, contributions, comparisons.
Practice questions
These are original questions written in the style of the ICAN exam. Try each one before you open the answer.
Section A style: multiple choice
Question 1. Gross domestic product measures:
- The value of final goods and services produced inside a country in a period
- The output of a country’s citizens wherever they are
- Total exports in a year
- Government spending in a year
Show the answer
A. GDP is by location of production. Option B describes GNP.
Question 2. Net national product is calculated as:
- GNP less depreciation
- GDP less indirect taxes
- GNP plus subsidies
- GDP plus net exports
Show the answer
A. NNP = GNP − depreciation.
Question 3. In the expenditure method, GDP equals:
- C + I + G
- C + I + G + (X − M)
- C + G + X
- I + G + M
Show the answer
B. Net exports, exports less imports, are added to domestic spending.
Question 4. Which of the following is excluded from national income?
- Wages
- Rent on land
- State pensions and other transfer payments
- Profits of firms
Show the answer
C. Transfer payments are not earned from producing goods and services.
Question 5. Real GDP is GDP measured at:
- Current prices
- Constant prices
- Factor cost only
- Foreign prices
Show the answer
B. Constant prices remove the effect of inflation, so real GDP shows changes in actual output.
Question 6. Double counting in national income is avoided by:
- Counting only final goods and value added
- Including transfer payments
- Counting all sales at every stage
- Using nominal values
Show the answer
A. Adding every sale would count intermediate goods several times.
Question 7. Which of these is an injection into the circular flow of income?
- Saving
- Taxes
- Investment
- Imports
Show the answer
C. Investment, government spending and exports are injections.
Question 8. If nominal GDP is ₦20,000 billion and the price index is 125, real GDP is:
- ₦16,000 billion
- ₦25,000 billion
- ₦20,125 billion
- ₦19,875 billion
Show the answer
A. 20,000 ÷ 1.25 = 16,000.
Question 9. In the output method, double counting is avoided by counting:
- All sales
- Value added
- Only imports
- Taxes
Show the answer
B. Add the value added at each stage or the final value.
Question 10. One reason why GDP per head is an imperfect measure of welfare is that it:
- Counts everything
- Hides inequality in the distribution of income
- Is always accurate
- Includes leisure
Show the answer
B. An average does not show how income is shared.
Section B style: written questions
Question 11 (10 marks). Explain the three methods of computing national income.
Show the marking guide
Output method (3 marks). Adds the value of final goods and services, or value added at each stage, then adjusts to factor cost and for net property income and depreciation.
Income method (3 marks). Adds factor incomes: wages, rent, interest and profit. Excludes transfer payments.
Expenditure method (3 marks). Adds final spending: C + I + G + (X − M).
Link (1 mark). The three give the same figure, because output equals income equals expenditure.
Question 12 (20 marks). An economy has these figures in ₦ billion: consumption 8,000; investment 2,500; government spending 3,000; exports 1,800; imports 1,500; indirect taxes 900; subsidies 200; net property income −400; depreciation 700. The population is 120 million.
(a) Calculate GDP at market prices and GDP at factor cost. (6 marks)
(b) Calculate GNP at factor cost and national income. (6 marks)
(c) Calculate income per head. (3 marks)
(d) Explain two problems of measuring national income. (5 marks)
Show the marking guide
(a) 6 marks.
- GDP at market prices.
8,000 + 2,500 + 3,000 + (1,800 − 1,500) = ₦13,800 billion (3). - GDP at factor cost.
13,800 − 900 + 200 = ₦13,100 billion (3).
(b) 6 marks.
- GNP at factor cost.
13,100 − 400 = ₦12,700 billion (3). - National income.
12,700 − 700 = ₦12,000 billion (3).
(c) 3 marks. ₦12,000 billion ÷ 120 million = ₦100,000 per head.
(d) 5 marks. Two problems, such as double counting and inadequate data, each with an explanation, so award 2 marks for each problem with its explanation, and 1 mark for a remedy.
A further written question
Question 13 (10 marks). Explain why GDP per head may be an inadequate measure of welfare.
Model answers
Show the model answer to Question 11
There are three methods of computing national income. The output (product) method adds the value of all final goods and services, or the value added at each stage, then adjusts to factor cost and for net property income and depreciation. The income method adds the incomes earned by the factors of production: wages, rent, interest and profits, excluding transfer payments.
The expenditure method adds all final spending: GDP = C + I + G + (X − M). In principle all three give the same figure, because output equals income equals expenditure.
Show the model answer to Question 12
(a)
- GDP at market prices.
8,000 + 2,500 + 3,000 + (1,800 − 1,500) = ₦13,800 billion. - GDP at factor cost.
13,800 − 900 + 200 = ₦13,100 billion.
(b)
- GNP at factor cost.
13,100 − 400 = ₦12,700 billion. - National income.
12,700 − 700 = ₦12,000 billion.
(c) Income per head = ₦12,000 billion ÷ 120 million = ₦100,000.
(d) Two problems. Double counting: counting intermediate goods as well as final output overstates the total, and it is avoided by counting only final goods or value added. Inadequate data: in many countries records are poor, so some methods cannot be used reliably, and the best available method is used. Others are non-marketed goods, depreciation, price changes and illegal income.
Show the model answer to Question 13
GDP per head is a useful average but an incomplete measure of welfare for several reasons. It hides distribution: a high average can coexist with great inequality. It leaves out non-marketed activity such as unpaid household work and much subsistence farming, and the informal economy, so it understates the output of many developing economies. It ignores quality of life: health, education, leisure, safety and a clean environment.
It may count harmful activity as gain, for instance spending on cleaning up pollution. And it does not capture quality and variety of goods. A fuller picture needs real income per head together with social indicators such as life expectancy and literacy.
Pathfinder on national income accounting
These are the ICAN Pathfinder questions that test this topic. ICAN owns the questions and the suggested solutions, so we point you to them and do not copy them. Open your Pathfinder, attempt each question under exam conditions, then check your answer against the notes above.
None of the diets mapped so far has a written question on this topic, so practise it through the multiple-choice questions. Check Section A of every diet for items on GDP, GNP, the three methods and the problems of measurement.
Revise first: The three methods of computing national income
Source: ICAN Pathfinder, Business Environment. Diets covered: May Diet, 2021 to May Diet, 2026. November Diet, 2024 is not yet mapped.
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