Labor Income (W)

Rental Income (R)

Interest Income (i)
Profits (PR)

NI = W + R + i + PR

Labor Income (W):

Salaries, wages, and fringe benefits such as health or retirement. This also includes unemployment insurance and
government taxes for Social Security.

Rental Income (R):

This is income received from property received by households. Royalties from patents, copyrights and assets as well
as imputed rent are included.

Interest Income (i):

Income received by households through the lending of their money to corporations and business firms. Government
and household interest payments are not included in the national income.

Profits (PR):
The amount firms have left after paying their rent, interest on debt, and employee compensation. GDP calculation
involves accounting profit and not economic profit.

Imputed Rent: This is the implicit rental value of owner-occupied houses.

Accounting Profit: The profit made from the total revenue received from the sale of the goods less the (explicit)
costs of producing these goods. It is calculated as total revenue minus explicit costs.

Economic Profit: This is calculated not only with the explicit costs of production, but with the implicit costs as well.
Economic profit is calculated as revenue minus implicit and explicit costs.

Using the Income Approach

Table 1 also contains the data necessary to calculate GDP using the income approach.

Table 1: Income

Transfer Payments $54

Interest Income (i) $150
Depreciation $36
Wages (W) $67
Gross Private Investment $124
Business Profits (PR) $200
Indirect Business Taxes $74
Rental Income (R) $75
Net Exports $18
Net Foreign Factor Income $12
Government Purchases $156
Household Consumption $304
In this case we use the formula:

NI = W + R + i + PR

W is the wages that are represented by $67 in the table.

Rental income is the R and is $75.
Interest income is i and is $150.
PR are business profits and are $200.

Therefore:

NI = $67 + $75 + $150 + $200

NI = $492

GDP = NI + Indirect Business Taxes + Depreciation

GDP = $492 + $74 + $36

GDP = $602

As you can see, in this case, both approaches to calculating GDP will give the same estimate. This is not always
what happens and sometimes GDP will differ slightly when the different approaches are used.

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What is 'Factor Income'
Factor income is income received from the factors of production – land, labor,
and capital. Factor income on the use of land is called rent, income generated
from labor is called wages and income generated from capital is called profit. The
factor income of all normal residents of a country is referred to as the national
income, and factor income plus current transfers is referred to as private income.

BREAKING DOWN 'Factor Income'

Factor income is most commonly used in macroeconomic analysis, and helps
governments determine the difference between Gross Domestic
Product and Gross National Product. For most countries the difference between
GDP and GNP is small, since income generated by citizens abroad and by
foreigners domestically often offset each other. A large difference in factor
income is more likely to be found in small, developing nations, where a significant
portion of income may be generated by foreign direct investment.

The proportional distribution of factor income across the factors of production is

also important in country-level analysis. Countries with low populations but great
mineral wealth may see a low proportion of factor income stemming from labor,
but a high proportion stemming from capital. Nations focusing on agriculture may
see an uptick in factor income derived from land, though crop failures or declining
prices may lead to decreases. Industrialization and increased productivity
generally cause rapid shifts in factor income distribution.

The income approach to measuring gross domestic product (GDP) is based on the accounting reality that
all expenditures in an economy should equal the total income generated by the production of all
economic goods and services. It also assumes that there are four major factors of production in an
economy and that all revenues must go to one of these four sources. Therefore, by adding all of the
sources of income together, a quick estimate can be made of the total productive value of economic
activity over a period. Adjustments must then be made for taxes, depreciation, and foreign factor
payments.

Ways to Calculate GDP

There are generally two ways to calculate GDP: the expenditures approach and the income approach.
Each of these approaches looks to best approximate the monetary value of all final goods and services
produced in an economy over a set period of time (normally one year).

The major distinction between each approach is its starting point. The expenditure approach begins with
the money spent on goods and services. Conversely, the income approach starts with the income
earned (wages, rents, interest, profits) from the production of goods and services.