Income approach

Another way of measuring GDP is to measure total income. If GDP is calculated this way it is sometimes called Gross Domestic Income (GDI), or GDP(I). GDI should provide the same amount as the expenditure method described below. (By definition, GDI = GDP. In practice, however, measurement errors will make the two figures slightly off when reported by national statistical agencies.)

This method measures GDP by adding incomes that firms pay households for factors of production they hire- wages for labour, interest for capital, rent for land and profits for entrepreneurship.

The US "National Income and Expenditure Accounts" divide incomes into five categories:

Wages, salaries, and supplementary labour income;

Corporate profits; Interest and miscellaneous investment income; Farmers’ income; Income from non-farm unincorporated businesses;

These five income components sum to net domestic income at factor cost.

Two adjustments must be made to get GDP:

1 Indirect taxes minus subsidies are added to get from factor cost to market prices.

2 Depreciation (or Capital Consumption Allowance) is added to get from net domestic product to gross domestic product.

A common formula for GDP is:

GDP = compensation of employees + gross operating surplus + gross mixed income + taxes less subsidies on production and imports.

GDP = COE + GOS + GMI + TP & M – SP & M

Compensation of employees (COE) measures the total remuneration to employees for work done. It includes wages and salaries, as well as employer contributions to social security and other such programs.

Gross operating surplus (GOS) is the surplus due to owners of incorporated businesses. Often called profits, although only a subset of total costs are subtracted from gross output to calculate GOS.

Gross mixed income (GMI) is the same measure as GOS, but for unincorporated businesses. This often includes most small businesses.

The sum of COE, GOS and GMI is called total factor income; it is the income of all of the factors of production in society. It measures the value of GDP at factor (basic) prices. The difference between basic prices and final prices (those used in the expenditure calculation) is the total taxes and subsidies that the government has levied or paid on that production. So adding taxes less subsidies on production and imports converts GDP at factor cost to GDP(I).