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Methods of Measuring GDP: Income Method

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Table of Content

Introduction

It measures GDP from the side of payments made to the primary factors of production in the form of rent, wages, interest and profit for their productive services in an accounting year.
It is calculated by adding up factor incomes generated by all the producing units located within the domestic economy during a period of account.
The sum of final expenditures in the economy must be equal to the incomes received by all the factors of production taken together (final expenditure is the spending on final goods, it does not include spending on intermediate goods).

Computation of GDP through Income Method

The income approach starts with the income earned from the production of goods and services.
Under the income approach, we calculate the income earned by all the factors of production in an economy.

National Income = Wages + Rent + Interest + Profits

This approach focuses on aggregating the payments made by firms to households, called factor payments.
This gives National Income, defined as the total income earned by citizens and businesses of a country.

Components

There are essentially four components to this method of calculation:

Wages and Salaries: Involves payments by firms to households for their labour services, i.e. wages and salaries, inclusive of all fringe benefits (example: pension contributions) before taxes.
Rent: This involves rental income and income from activities of farms and non-incorporated non-farm entities.
Interest Payments: Interest Incomes on loans.
Profits (In the form of dividends): Before tax, profits of firms that are owned by the households and the government. Only incorporated firms with limited liability are included here.

Important points

Only factor incomes which are earned by rendering productive services are included while calculating GDP using the income method. All types of transfer income like old-age pension, unemployment allowance, etc. are excluded.
Sale and purchase of second-hand goods are excluded since they are not part of the production of the current year, but the commission paid on the sale of second-hand goods is included as a reward for rendering productive services. Likewise, the sale proceeds of shares and bonds are not included.
Income from illegal activities like smuggling, black-marketing, etc. as well as windfall gains (e.g., from lotteries) is excluded.
Direct taxes such as income tax which is paid by the employees from their salaries; and corporate tax, which is paid by the joint stock company from its profit, are included.