Before ANY income is received by anyone in the household sector it must be earned by resources through the production of goods and services. The most important lesson of the circular flow model is that income is generated from production. No one RECIEVES income unless someone earns it through production. As such, national income (income earned) is the ULTIMATE source of personal income (income received).

While personal income and national income are conceptually different, quantitatively they are almost equal. Personal income tends to be only about 2 to 3 percent greater than national income. This extra 2 to 3 percent comes largely from productive activity of the government sector that is not attributable directly to the earnings the factors of production and thus is not part of national income.

Personal income can be derived in a two ways. One is by adding ALL of the income received from various sources by members of the household sector. A second is to adjust national income for income earned but not received (IEBNR) and income received but not earned (IRBNE).

Components of Personal Income

• Wages: Labor earnings account for over 60 percent of personal income. The official National Income and Product Accounts entries for labor are wage and salary disbursements and other labor income. These are NOT the same as the compensation of employees entry contained in national income. Compensation of employees includes total wages earned by labor. However, these two personal income categories for wages ONLY include that portion of wages received. The primary employment compensation earned, but excluded is fringe benefits (especially retirement, health care, and most notably Social Security taxes).


• Interest: The official personal income component for interest is termed personal interest income. It includes interest that members of the household sector receive from bank accounts, mutual funds, savings bonds, and other similar loans. This is typically about 10 to 12 percent of personal income.


• Rent: Rental income of persons is the official personal income component capturing rent. This includes rent that members of the household sector receive from the ownership of property, including land and any attached capital. Rental income of persons is about 2 to 3 percent of personal income.


• Profit: The primary measurement of profit included in the personal income is termed personal dividend income, which typically makes up 2 to 4 percent of the personal income. Dividends are that portion of corporate profits actually paid out to shareholders. Two other portions of corporate profits that are NOT paid out as dividends are used for undistributed corporate profits (or retained earnings) and corporate profits taxes.


• Proprietors' Income: Because the owners of proprietorships (and some partnerships) receive a single income payment, rather than separate wage, interest, rent, or profit payments, their incomes warrant a separate component in personal income. Proprietors' income accounts for about 8 to 10 percent of personal income.


• Transfer Payments: The first five components of personal income represent income that is both EARNED and RECEIVED by the factors of production and account for about 80 to 85 percent of personal income. The remaining 15 to 20 percent comes from transfer payments. Transfer payments are income RECEIVED by members of the household sector but not EARNED as the result of any current productive activity. The three most noted examples of transfer payments are welfare, unemployment compensation, and Social Security.

PI

=

Wages Received + Interest Received + Rent Received + Dividends + Proprietors' Income + Transfer Payments

Adjusting National Income

• Income Earned But Not Received: The three primary types of income earned but not received by the factors of production are Social Security taxes, corporate profits taxes, and undistributed corporate profits. Social Security taxes are "contributions" to the Social Security system made by labor. These are wages earned, but not received. Corporate profits taxes are taxes on the profits earned by corporate shareholders. These profits are paid to the government and are thus not available for dividend payment. Undistributed corporate profits are a portion of the profits earned by corporate shareholders that could be paid out as dividends, but are retained to finance capital investment.


• Income Received But Not Earned: The three types of income received but not earned are Social Security payments, unemployment compensation payments, and welfare payments. These are also the three key transfer payments from the government sector to the household sector. Social Security payments are the payments from the Social Security system to elderly and disabled members of the household sector. Unemployment compensation payments are transfer payments from the government sector to unemployed members of the household sector. And welfare payments are transfer payments from the government sector to poor members of the household sector.

PI

=

NI - Income Earned But Not Received + Income Received But Not Earned