The income approach
The income approach equates the total output of a nation to the total factor income received by residents of the nation. The main types of factor income are:
- Employee compensation (= wages + cost of fringe benefits, including unemployment, health, and retirement benefits);
- Interest received net of interest paid;
- Rental income (mainly for the use of real estate) net of expenses of landlords;
· Royalties paid for the use of intellectual property and extractable natural resources.
All remaining value added generated by firms is called the residual or profit. If a firm has stockholders, they own the residual, some of which they receive as dividends. Profit includes the income of the entrepreneur – the businessman who combines factor inputs to produce a good or service.
Formulae: NDP at factor cost = Compensation of employees + Net interest + Rental & royalty income + Profit of incorporated and unincorporated firms + Income from self-employment. National income = NDP at factor cost + NFIA (net factor income from abroad) - Depreciation.
The expenditure approach
The expenditure approach is basically an output accounting method. It focuses on finding the total output of a nation by finding the total amount of money spent. This is acceptable, because like income, the total value of all goods is equal to the total amount of money spent on goods. The basic formula for domestic output combines all the different areas in which money is spent within the region, and then combining them to find the total output.
GDP = C + I + G + (X – M)
Where:
C = household consumption expenditures / personal consumption expenditures
I = gross private domestic investment
G = government consumption and gross investment expenditures
X = gross exports of goods and services
M = gross imports of goods and services
Note: (X – M) is often written as XN, which stands for “net exports”