Chapter 16: Problem 3

How is the GDP calculated by the income approach? What are the different components of income?

Short Answer

Expert verified

Answer: The main components of income considered in the income approach to calculating GDP are compensation of employees, gross operating surplus, taxes (less subsidies) on production and imports, and depreciation (consumption of fixed capital). These components are combined in the following formula to determine GDP: GDP = Compensation of employees + Gross operating surplus + Taxes (less subsidies) on production and imports + Depreciation.

Step by step solution

Brief Overview of GDP and Income Approach

Gross Domestic Product (GDP) is the monetary value of all goods and services produced within a country in a specified period. There are three different approaches to calculating GDP: output approach, expenditure approach, and income approach. In this exercise, we are focusing on the income approach. The income approach calculates GDP by summing up all the incomes earned within a country during a specific period, including wages, profits, rents, and taxes.

Components of Income

In the income approach, there are several components of income that need to be considered when calculating GDP. The main components are: 1. Compensation of employees: This includes salaries, wages, and other forms of compensation earned by workers. 2. Gross operating surplus: Profit generated by businesses and corporations, which includes both the gross mixed income of unincorporated businesses and the gross profits of corporations. 3. Taxes (less subsidies) on production and imports: Represents the net amount paid in taxes by businesses, after accounting for any subsidies received. 4. Depreciation (consumption of fixed capital): The value of capital that is used up or worn out in the production process.

Calculate Compensation of Employees

The first step in calculating GDP using the income approach is to add up the total compensation of employees earned within the country during the given period. This includes their salaries, wages, and other benefits received in exchange for labor.

Calculate Gross Operating Surplus

The second step is to calculate the gross operating surplus. This is the profit generated by businesses and corporations, including both the gross mixed income of unincorporated businesses and the gross profits of corporations. To do this, we sum up the profits earned by each business or corporation during the period.

Calculate Taxes (less subsidies) on Production and Imports

The third step is to calculate taxes (less subsidies) on production and imports. This is the net amount paid in taxes by businesses, after accounting for any subsidies received. For example, if a company pays $1,000 in taxes but receives $200 in subsidies, the net taxes (less subsidies) paid would be $800.

Calculate Depreciation (Consumption of Fixed Capital)

Finally, we need to calculate the depreciation or consumption of fixed capital. Depreciation represents the value of capital that is used up or worn out in the production process over the specified period. This could include things like machinery, equipment, and buildings that lose value over time due to wear and tear.

Summing Up All Components

Once we have calculated each component (compensation of employees, gross operating surplus, taxes (less subsidies) on production and imports, and depreciation), we sum them all up to calculate the GDP using the income approach. The formula is: GDP = Compensation of employees + Gross operating surplus + Taxes (less subsidies) on production and imports + Depreciation. By following these steps and calculating each component, we can determine the GDP of a country using the income approach.

Unlock Step-by-Step Solutions & Ace Your Exams!

Full Textbook Solutions
Get detailed explanations and key concepts
Unlimited Al creation
Al flashcards, explanations, exams and more...
Ads-free access
To over 500 millions flashcards
Money-back guarantee
We refund you if you fail your exam.

Start your free trial

Over 30 million students worldwide already upgrade their learning with Vaia!