## Measuring Total Output and Income

Read this chapter, to learn about measuring domestic output, and attempt the "Try It" exercises. The material in this chapter concentrates on the four components of GDP: consumption, investment, government purchases, and net exports. Pay attention to the definition of these components as it may differ from your expectations. For example, note that Investment does not refer to the common knowledge definition of investment as in the trading of stock and bonds. Instead, the Investment component refers mainly to the purchase of physical machinery and equipment needed in the production of goods and services. You will revisit certain sections of the chapter later in this unit.

### 6.2 Measuring Total Income

#### The Components of GDI

Employee compensation is the largest among the components of factor income. Factor income also includes profit, rent, and interest. In addition, GDI includes charges for depreciation and taxes associated with production. Depreciation and production-related taxes, such as sales taxes, make up part of the cost of producing goods and services and must be accounted for in estimating GDI. We will discuss each of these components of GDI next.

#### Employee Compensation

Compensation of employees in the form of wages, salaries, and benefits makes up the largest single component of income generated in the production of GDP. In the third quarter of 2011, employee compensation represented 55% of GDI.

The structure of employee compensation has changed dramatically in the last several decades. In 1950, virtually all employee compensation - 95% of it - came in the form of wages and salaries. The remainder, about 5%, came in the form of additional benefits such as employer contributions to retirement programs and health insurance. In 2011, the share of benefits was nearly 20% of total employee compensation.

#### Profits

The profit component of income earned by households equals total revenues of firms less costs as measured by conventional accounting. Profits amounted to about 17% of GDI in 2011, down sharply from five decades earlier, when profits represented about 25% of the income generated in GDI. Although reported separately by the Department of Commerce, we have combined proprietors' income (typically independent business owners and farmers) with corporate profits to simplify the discussion.

Profits are the reward the owners of firms receive for being in business. The opportunity to earn profits is the driving force behind production in a market economy.

#### Rental Income

Rental income, such as the income earned by owners of rental housing or payments for the rent of natural resources, is the smallest component of GDI (less than 3%); it is the smallest of the income flows to households. The meaning of rent in the computation of GDI is the same as its meaning in conventional usage; it is a charge for the temporary use of some capital asset or natural resource. If you have studied microeconomics, you know that the term "rent" in economics has a quite different meaning. The national income and product accounts use the accounting, not the economic, meaning of "rent".

#### Net Interest

Businesses both receive and pay interest. GDI includes net interest, which equals interest paid less interest received by domestic businesses, plus interest received from foreigners less interest paid to foreigners. Interest payments on mortgage and home improvement loans are counted as interest paid by businesses, because homeowners are treated as businesses in the income accounts. In 2011, net interest accounted for about 5% of GDI.

#### Depreciation

Over time the machinery and buildings that are used to produce goods and services wear out or become obsolete. A farmer's tractor, for example, wears out as it is used. A technological change may make some equipment obsolete. The introduction of personal computers, for example, made the electric typewriters used by many firms obsolete. Depreciation is a measure of the amount of capital that wears out or becomes obsolete during a period. Depreciation is referred to in official reports as the consumption of fixed capital.

Depreciation is a cost of production, so it represents part of the price charged for goods and services. It is therefore counted as part of the income generated in the production of those goods and services. Depreciation represented about 13% of GDI in 2011.

#### Indirect Taxes

The final component of the income measure of GDI is indirect business taxes.The adjustment for indirect business taxes includes two other minor elements: transfer payments made by business firms and surpluses or deficits of government enterprises.  Indirect taxes are taxes imposed on the production or sale of goods and services or on other business activity. (By contrast, a direct tax is a tax imposed directly on income; the personal income and corporate income taxes are direct taxes). Indirect taxes, which include sales and excise taxes and property taxes, make up part of the cost to firms of producing goods and services. Like depreciation, they are part of the price of those goods and services and are therefore treated as part of the income generated in their production. Indirect business taxes amounted to nearly 8% of GDI in 2011.

Table 6.2 GDP and GDI, 2011

 Gross domestic product $15,176.1 Gross domestic income$15,214.8 Personal consumption expenditures $10,784.5 Compensation of employees 8,347.3 Gross private domestic investment$1,906.6 ProfitsProfit is corporate profit ($1,519.3) plus proprietors' income ($1,113.7), both with inventory valuation and capital consumption adjustment. 2,633.0 Government consumption expenditures and gross investment $3,047.3 Rental income of persons 406.3 Net exports of goods and services −$562.3 Net interest 710.3 Taxes on production and importsIndirect taxes include taxes on production and imports of $1,100.0 plus business transfer payments ($133.7) less subsidies ($64.2) and current surplus of government enterprise ($14.5). Prior to the 2003 National Income and Product Accounts (NIPA) revisions, the category “taxes on production and imports” was, with some technical and other minor adjustments, referred to as “indirect business taxes.” See Brent R. Moulton and Eugene P. Seskin, “Preview of the 2003 Comprehensive Revision of the National Income and Product Accounts,” Bureau of Economic Analysis, Survey of Current Business, June 2003, pp. 17–34. 1,155.1 Consumption of fixed capital (depreciation) 1,962.8 Statistical discrepancy −38.7

Table 6.2 "GDP and GDI, 2011" shows the components of GDI in the third quarter of 2011. Employee compensation represented the largest share of GDI. The exhibit also shows the components of GDP for the same year.

In principle, GDP and GDI should be equal, but their estimated values never are, because the data come from different sources. Output data from a sample of firms are used to estimate GDP, while income data from a sample of households are used to estimate GDI. The difference is the statistical discrepancy shown in the right-hand column of Table 6.2 "GDP and GDI, 2011". Some of the difficulties with these data are examined in the Case in Point feature on discrepancies between GDP and GDI.

Table 6.2 GDP and GDI, 2011

 Gross domestic product $15,176.1 Gross domestic income$15,214.8 Personal consumption expenditures $10,784.5 Compensation of employees 8,347.3 Gross private domestic investment$1,906.6 ProfitsProfit is corporate profit ($1,519.3) plus proprietors' income ($1,113.7), both with inventory valuation and capital consumption adjustment. 2,633.0 Government consumption expenditures and gross investment $3,047.3 Rental income of persons 406.3 Net exports of goods and services −$562.3 Net interest 710.3 Taxes on production and importsIndirect taxes include taxes on production and imports of $1,100.0 plus business transfer payments ($133.7) less subsidies ($64.2) and current surplus of government enterprise ($14.5). Prior to the 2003 National Income and Product Accounts (NIPA) revisions, the category "taxes on production and imports" was, with some technical and other minor adjustments, referred to as "indirect business taxes". 1,155.1 Consumption of fixed capital (depreciation) 1,962.8 Statistical discrepancy −38.7

The table shows the composition of GDP and GDI in the third quarter of 2011 (in billions of dollars at an annual rate). Notice the rough equality of the two measures. (They are not quite equal because of measurement errors; the difference is due to a statistical discrepancy and is reduced significantly over time as the data are revised).