COMPONENTS OF GDP (INCOME APPROACH)

In our previous post, we define GDP as the market value of all final goods and services produced within the confines of the country in a given period.

However, goods produced must be sold, which means, buyers will spend their money and sellers will receive such money as income.

This buyer's spending can be in four forms: Household spending, business spending, government spending, and spending on net export. We previously discussed these four buyers' spending components.

So, let's turn our focus on the other side of the spectrum, which is, the seller's income

The income approach of calculating GDP measures the total income received from all final and goods services produced in a country at a given period.

To calculate GDP using the income approach, simply add total national income, indirect taxes, depreciation, and then subtract subsidies.

Expressing this statement mathematically, we have:

$GDP=TNI+T+D-S$

Where TNI is the Total national income

               T is an indirect tax

               D is depreciation

                S is subsidy

Now, let take a closer look at each component of GDP

Total national income

This is simply the sum of all factor payments. Total national income is, by definition, the sum of the following:

1. Wages and salaries: This is the total amount of money paid by businesses to households for labor services rendered. It includes wages and salaries, as well as additional fringe benefits such as pension contributions before tax

2. Rent: This is the sum of rental income by farm and nonfarm entities

3. Interest: capital payments, particularly interest income on a loan

4. Corporate Profits: These consist of the before-tax profits of firms that are owned by households and the government. 

For example, if a country report €7 trillion was paid as wages payment, €2 trillion as interest, €4 trillion as profit, 3 trillion as rents payment, its total national income will be:

$TNI=7+3+4+3$

$TNI=17$

Therefore, its total national income is €17 trillion

Indirect tax

Often, the government levies a tax on goods and services. Because these taxes do not serve as wages, interest, profits, or rent, we must add them to national income separately.

These taxes are collectively called indirect taxes, and they can include sales tax and production tax. . As a result, we include indirect taxes in our GDP calculations.

Depreciation

As all accountants know, the value of an asset decreases over time. This is called depreciation or capital consumption allowance.

Because depreciation cannot be linked to cash flow, it is excluded from national income by default. This is so because profits are calculated net of depreciation.

However, because depreciation affects profit, it must be added to the account for this profit reduction separately. Hence, we add depreciation. F

Subsidy

The government frequently provides financial assistance to businesses to help them support their operations. It's referred to as a subsidy, and it's a type of transfer payment.

When companies calculate earnings, they don't take into account the government subsidy they received.
This would imply that profit is overstated.

To give an accurate description of GDP, we must deduct subsidies separately to account for any subsidy businesses that may have resulted in inflated profits.

To repeat: $GDP=TNI+T+D-S$

let's take an example.

Calculate the GDP if the total national income is €20 trillion, sales tax is €1 trillion, depreciation is €1 trillion

Answer

$GDP=20+1+1$

$GDP=22$

Therefore, the total GDP is €22 trillion.

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