# Principles of Macroeconomics, v. 1.0

by Libby Rittenberg and Timothy Tregarthen

## 6.2 Measuring Total Income

### Learning Objectives

1. Define gross domestic income and explain its relationship to gross domestic product.
2. Discuss the components of gross domestic income.
3. Define disposable personal income and explain how to calculate it from GDP.

We saw in the last section that the production of goods and services generates factor incomes to households. The production of a given value of goods and services generates an equal value of total income. Gross domestic income (GDI)The total income generated in an economy by the production of final goods and services during a particular period. equals the total income generated in an economy by the production of final goods and services during a particular period. It is a flow variable. Because an economy’s total output equals the total income generated in producing that output, GDP = GDI. We can estimate GDP either by measuring total output or by measuring total income.

Consider a $4 box of Cheerios. It is part of total output and thus is part of GDP. Who gets the$4? Part of the answer to that question can be found by looking at the cereal box. Cheerios are made from oat flour, wheat starch, sugar, salt, and a variety of vitamins and minerals. Therefore, part of the $4 goes to the farmers who grew the oats, the wheat, and the beets or cane from which the sugar was extracted. Workers and machines at General Mills combined the ingredients, crafted all those little O’s, toasted them, and put them in a box. The workers were paid part of the$4 as wages. The owners of General Mills and the capital it used received part of the $4 as profit. The box containing the Cheerios was made from a tree, so a lumber company somewhere received part of the$4. The truck driver who brought the box of cereal to the grocery store got part of the $4, as did the owner of the truck itself and the owner of the oil that fueled the truck. The clerk who rang up the sale at the grocery store was paid part of the$4. And so on.

How much of the $4 was income generated in the production of the Cheerios? The answer is simple: all of it. Some of the money went to workers as wages. Some went to owners of the capital and natural resources used to produce it. Profits generated along the way went to the owners of the firms involved. All these items represent costs of producing the Cheerios and also represent income to households. Part of the$4 cost of the Cheerios, while it makes up a portion of GDI, does not represent ordinary income actually earned by households. That part results from two other production costs: depreciation and taxes related to the production of the Cheerios. Nevertheless, they are treated as a kind of income; we will examine their role in GDI below.

As it is with Cheerios, so it is with everything else. The value of output equals the income generated as the output is produced.

## 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 second quarter of 2008, employee compensation represented 57% 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 2008, the share of benefits was roughly 19% of total employee compensation.

## Profits

### Case in Point: The GDP–GDI Gap

Figure 6.8

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:  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.