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Tracing Income from the Economy to Households

25 April, 2016 - 09:12

We have seen that the production of goods and services generates income for households. Thus, the value of total output equals the value of total income in an economy. But we have also seen that our measure of total income, GDI, includes such things as depreciation and indirect business taxes that are not actually received by households. Households also receive some income, such as transfer payments, that does not count as part of GDP or GDI. Because the income households actually receive plays an important role in determining their consumption, it is useful to examine the relationship between a nation’s total output and the income households actually receive.

The Table 21.3 below traces the path we take in going from GDP to disposable personal income, which equals the income households have available to spend on goods and services. We first convert GDP to GNP and then subtract elements of GNP that do not represent income received by households and add payments such as transfer payments that households receive but do not earn in the production of GNP.

Disposable personal income is either spent for personal consumption or saved by households.

Table 21.3 From GDP to Disposable Personal Income

GDP + net factor earnings from abroad

=

Gross national product (GNP)

GNP − depreciation (consumption capital)

=

Net national product (NNP)

NNP − statistical discrepancy

=

National income (NI)

NI − income earned but not receive taxes on production and imports, social security payroll tax profit taxes, and retained earnings] + transfer payments and other income received but not earned in the production of GNP

=

Personal income (PI)

PI – personal income taxes

=

Disposable personal income (DPI)

 

GDP, a measure of total output, equals GDI, the total income generated in the production of goods and services in an economy. The chart traces the path from GDP to disposable personal income, which equals the income households actually receive. We first convert GDP to GNP. Then, we subtract depreciation to obtain net national product and subtract the statistical discrepancy to arrive at national income (i.e., gross national income [GNI] net of depreciation and the statistical discrepancy). Next, we subtract components of GNP and GNI that do not represent income actually received by households, such as taxes on production and imports, corporate profit and payroll taxes (contributions to social insurance), and corporate retained earnings. We add items such as transfer payments that are income to households but are not part of GNP and GNI. The adjustments shown are the most important adjustments in going from GNP and GNI to disposable personal income; several smaller adjustments (e.g., subsidies, business current enterprises) have been omitted.

KEY TAKEAWAYS

  • Gross domestic product, GDP, equals gross domestic income, GDI, which includes compensation, profits, rental income, indirect taxes, and depreciation.
  • We can use GDP, a measure of total output, to compute disposable personal income, a measure of income received by households and available for them to spend.

TRY IT!

The following income data refer to the same economy for which you had output data in the first part of the previous Try It! Compute GDI from the data below and confirm that your result equals the GDP figure you computed in the previous Try It! Assume that GDP = GNP for this problem (that is, assume all factor incomes are earned and paid in the domestic economy).

Table 21.4

Employee compensation

$700

Social Security payments to households

40

Welfare payments

100

Profits

200

Rental income

50

Net interest

25

Depreciation

50

Indirect taxes

175

 

Case in Point: The GDP–GDI Gap

GDP equals GDI; at least, that is the way it is supposed to work. But in an enormously complex economy, the measurement of these two variables inevitably goes awry. Estimates of the two are never quite equal. In recent years, the absolute value of the gap has been quite sizable. For 2007 and 2008, for example, GDI has differed from GDP by −$81.4 and $160.5 billion per year, respectively. Although the gap seems large, it represents a remarkably small fraction of measured activity—around 1% or less. Of course, 1% of a big number is still a big number. But it is important to remember that, relative to the size of the economy, the gap between GDI and GDP is not large. The gap is listed as a “statistical discrepancy” in the Department of Commerce reporting of the two numbers. Why does the gap exist? From an accounting point of view, it should not. The total value of final goods and services produced must be equal to the total value of income generated in that production. But output is measured from sales and inventory figures collected from just 10% of commercial establishments. Preliminary income figures are obtained from household surveys, but these represent a tiny fraction of households. More complete income data are provided by income tax returns, but these are available to the economists who estimate GDI only after a two- to four-year delay. The Department of Commerce issues revisions of its GDP and GDI estimates as more complete data become available. With each revision, the gap between GDP and GDI estimates is significantly reduced. While GDP and GDI figures cannot provide precise measures of economic activity, they come remarkably close. Indeed, given that the numbers come from entirely different sources, the fact that they come as close as they do provides an impressive check of the accuracy of the department’s estimates of GDP and GDI.

ANSWER TO TRY IT! PROBLEM

GDI equals $1,200. Note that this value equals the value for GDP obtained from the estimate of output in the first part of the previous Try It! Here is the computation:

Table 21.5

Employee compensation

$700

Profits

200

Rental income

50

Net interest

25

Depreciation

50

Indirect taxes

175

GDI

$1,200

 



Once again, note that Social Security and welfare payments to households are transfer payments. They do not represent payments to household factors of production for current output of goods and services, and therefore are not included in GDI.