The expenditure method leads to gross domestic product. The income method leads to gross domestic income. In a perfect world, where every calculation is accurate, no mistakes are made, and all production and income are correctly identified, gross domestic product and gross domestic income are EXACTLY equal. But in the imperfect real world, there is almost always a discrepancy between these two measures. This discrepancy is generally quite small, less than 1 percent of GDP.

Two Sides of the Market

The overall value of production, which is what GDP seeks to measure, is determined mutually by buyers and sellers through such market exchanges. On one side of market exchanges is the suppliers, producing and selling goods. On the other side is demanders, purchasing and using goods. For each good sold, someone buys. For each good bought, someone sells. The number crunchers at the Bureau of Economic Analysis use this two-sided notion to derive a relatively accurate estimate of total production (that is, gross domestic product) using total income.

To illustrate, consider the purchase of a Hot Momma Fudge Bananarama Ice Cream Sundae by Duncan Thurly for $2. His demand-side of the transaction involves giving up $2 and getting (and presumably enjoying) a Hot Momma Fudge Bananarama Ice Cream Sundae. However, from the supply-side of this transaction, the Hot Momma Fudge Bananarama Ice Cream Shoppe receives the $2 in payment for producing the Hot Momma Fudge Bananarama Ice Cream Sundae. If the store does not produce, then Duncan does not buy. And if Duncan does not buy, the store does not produce.

As such, a reasonable estimate of Hot Momma Fudge Bananarama Ice Cream Sundae production can be derived by adding up the revenue received by the Hot Momma Fudge Bananarama Ice Cream Shoppe and how the revenue becomes income of the productive resources. This is gross domestic income, which in principle is equal to gross domestic product.

What Makes Up GDI

GDI

=

Compensation of Employees + Net Interest + Rental Income of Persons + Corporate Profits + Proprietors' Income + Capital Consumption Adjustment + Indirect Business Taxes + Business Transfer Payments - Net Foreign Factor Income - Government Subsidies less Current Surplus of Government Enterprises

• Compensation of Employees: The official measure of wages earned by the household sector for supplying labor services. It includes standard wages and salaries paid directly to employees, as well as fringe benefits paid on behalf of employees to third parties.


• Net Interest: The official measure of interest earned by the household sector for supplying capital services. It is revenue generated from borrowed funds but is considered payment for the productive services of capital.


• Rental Income of Persons: The official measure of rent earned by the household sector for supplying land and related services. It includes payments for the use of land, natural resources, and capital goods attached to the land.


• Corporate Profits: The total accounting profits received by corporations, which is the official measure of profit earned by the household sector for supplying entrepreneurship services through corporations.


• Proprietors' Income: The excess of revenue over explicit production cost of owner-operated businesses which includes payments to all factors of production--labor, capital, land, and entrepreneurship.


• Capital Consumption Adjustment: The portion of revenue set aside by the business sector to compensate for the depreciation of capital resulting from the production of final goods.


• Indirect Business Taxes: The official term for sales taxes. They are termed INDIRECT business taxes because the business sector is only acting as the "collection agency" for the government, collecting the taxes from the household sector.


• Business Transfer Payments: Subsidies, or gifts, made from the business sector to the household sector. It includes outright gifts (such as student scholarships), and more importantly, accounting adjustments for unpaid debts of the household sector.


• Net Foreign Factor Income: The difference between factor payments received from the foreign sector by domestic citizens and factor payments made to foreign citizens for domestic production is termed net foreign factor income. This is also the key difference between gross DOMESTIC product and gross NATIONAL product.


• Government Subsidies Less Surplus of Government Enterprises: Government subsidies are transfer payments from the government sector to the business sector which are NOT payments for current production. These subsidies are adjusted by the current surplus of government enterprises, which is the "profit" of government run business activities.

The first five items listed are the factor payments that make up national income. The next five items reflect differences between gross domestic product and national income. Of course, the only adjustment item NOT included in this list is the statistical discrepancy.

The Statistical Discrepancy

The statistical discrepancy is officially "added" to gross domestic income when calculating gross domestic product, but the actual value can be positive or negative. The value of the statistical discrepancy is whatever it needs to be to equate the income and expenditure approaches to measuring gross domestic product.

This equation summarizes the connection between gross domestic product (GDP), gross domestic income (GDI), and the statistical discrepancy (SD):

GDP

=

GDI

+

SD