Measuring GDP: The Income Approach

1. Measuring GDP: The Income Approach Claudia Garcia-Szekely ©2000Claudia Garcia-Szekely

2. Measuring Economic Activity There are several ways of measuring economic activity: • The expenditures Approach: Measures expenditures by all sectors in the economy. • The Incomes Approach: measures incomes received by all participants in the economy • The Value Added Approach: measures the value each firm adds to intermediate goods at each stage of production ©2000Claudia Garcia-Szekely

3. GDP Total Income from Production National Income Government Depreciation Rest of The World Indirect Taxes-Subsidies (Wages, Interest, Rents and Profits) Net Factor payments to ROW Distribution of Income Generated from Production Income put aside to replace equipment What people receive What the Government receives Income paid to the Rest of World ©2000Claudia Garcia-Szekely

4. National Income What people receive ©2000Claudia Garcia-Szekely

5. National Income What people receive • Payments to workers (wages, salaries) • Incomes to small business owners (proprietor's income) • Corporate Profits • Interest* (paid by business) • Rental income. How Income is earned ©2000Claudia Garcia-Szekely

6. Government What the Government receives ©2000Claudia Garcia-Szekely

7. The Income Approach GDP = National Income + Indirect Taxes… • Indirect taxes (sales tax, etc) are not paid as income to households but form part of the income generated from production. ©2000Claudia Garcia-Szekely

8. The Income Approach GDP = National Income + (Indirect Taxes – Subsidies)… Subsidies are subtracted from taxes to obtain the “net” amount taken by the government not paid to households as income. ©2000Claudia Garcia-Szekely

9. Depreciation ©2000Claudia Garcia-Szekely

10. The Income Approach GDP = National Income + (Indirect Taxes – Subsidies) + Depreciation … Depreciation is not “Income to households” but it is part of the Income generated from production. ©2000Claudia Garcia-Szekely

11. Net Factor Payments to the Rest of the World Income paid to the Rest of World ©2000Claudia Garcia-Szekely

12. Factor Payments to Rest of the World (ROW) Income generated in the US that leaves the US • Income paid to foreign owned resources located in the US. • These payments are made to the rest of the world and do not stay in the US as income to nationals. ©2000Claudia Garcia-Szekely

13. Receipts of Factor Income from the ROW Income generated outside the US that enters the US • Income received from the ROW as payments to US-owned resources located in other countries. • This income received by US nationals from other countries did not originate in US production (GDP) ©2000Claudia Garcia-Szekely

14. The Income Approach GDP = National Income + (Indirect Taxes – Subsidies) + Depreciation + Net Factor payments to Rest of the World ©2000Claudia Garcia-Szekely

15. Income generated outside the US that enters the US Income generated in the US that leaves the US Net Factor Payments = Payments - Receipts These net payments made to other countries constitute U.S. generated income that does not stay in the U.S. These payments must be added to National Income to get the total income generated from production in the U.S. ©2000Claudia Garcia-Szekely

16. What if Receipts are greater than Payments? In this case, Payments – Receipts will be a negative number and instead of adding we would subtract… Suppose that the U.S. does not make any payments to the ROW but the ROW does make payments to the U.S.? ©2000Claudia Garcia-Szekely

17. Taxes pay Receipts $ Payments Subsidies Depreciation Indirect National Income Interest Rent Profits Wages Circular Flow Diagram Net Pay Rest of World Firms $Goods and Services Net tax

18. NetPayments $ Depreciation Government Ind. Tx - Subs. GDP = National Income + Depreciation + (Indirect Taxes – Subsidies) + Net Factor Payments to Rest of the World National Income Circular Flow Diagram Interest Rent Profits Wages Rest of World $Goods and Services GDP

19. From Gross to Net Gross Domestic Product Net Domestic Product Subtract Depreciation Gross Domestic Product Net Domestic Product Add Depreciation ©2000Claudia Garcia-Szekely

20. From Domestic to National Gross Domestic Product Gross Domestic Product Add Receipts from ROW Subtract Payments to ROW Subtract Net Payments to the Rest of the World Subtract Receipts from ROW Add Payments to ROW ADD Net Payments to the Rest of the World Gross National Product Gross National Product ©2000Claudia Garcia-Szekely

21. GDP Measured as Income Tax Interest Rent Depreciation Profits Wages Net Income From abroad Proprietors’ Income ©2000Claudia Garcia-Szekely

22. Print to Read • http://www.bea.doc.gov/bea/dn1.htm • Latest NIPA tables for GDP • Interactive NIPA Tables • Choose a table from a list of All NIPA Tables • Table 1.7.5 Relation GDP, GNP, NNP, NI and PI • Table 1.12 National Income by type of income: Quarterly 2001 – 2003 DO NOT FORGET TO CHOOSE: File Page Setup Landscape Print ©2000Claudia Garcia-Szekely

23. Value Added Approach The difference in value between what a firm pays for intermediate goods and what it receives for the finished product is called the firm’s Value Added. The Value Added Approach to measuring GDP is the sum of the values added by all firms. ©2000Claudia Garcia-Szekely

24. Value Added Approach Value Added = Firms’ revenues – cost of intermediate goods. Value Added = Total Sales – cost of intermediate goods. ©2000Claudia Garcia-Szekely

25. Value Added Approach GDP = Sum of value added by all firms at each stage of production. ©2000Claudia Garcia-Szekely

26. Example • The Economy produces three goods: wheat, flour and bread. • Final consumers purchase part of the flour and all the bread but none of the wheat. ©2000Claudia Garcia-Szekely

27. =Total Sales – cost of intermediate goods. Wheat industry does not buy intermediate goods Value added by Wheat Industry Value added by Flour Industry Value added by Bread Industry