How is the income approach used to compute GDP?

The income approach computes GDP by adding up all the incomes earned by households and businesses in a country.

The income approach, also known as the factor income method, is one of the three main methods used to calculate Gross Domestic Product (GDP). It is based on the principle that the total product output of an economy is equal to the total income earned by all factors of production, namely labour, capital, and land. This approach essentially views GDP from the recipient's side - the income received by all the producers in the country.

The income approach includes several components. Firstly, it considers the wages, salaries, and supplementary labour income, which is the income earned by individuals from their work. This includes not only direct wages and salaries, but also benefits such as pensions and health insurance.

Secondly, it includes the gross operating surplus of corporations, which is essentially the profits of companies. This includes not only the net income of corporations but also capital consumption allowances, which are the allowances for the depreciation of capital goods.

Thirdly, it includes the gross mixed income, which is the income earned by unincorporated businesses, such as sole proprietorships and partnerships. This includes both labour income and capital income.

Lastly, it includes taxes less subsidies on production and imports. Taxes on production and imports are added because they are part of the cost of producing goods and services, while subsidies are subtracted because they reduce the cost of production.

To calculate GDP using the income approach, these components are added together. The formula is: GDP = Compensation of employees + Gross operating surplus + Gross mixed income + Taxes less subsidies on production and imports.

It's important to note that the income approach should, in theory, give the same GDP figure as the expenditure approach, which calculates GDP by adding up all spending on goods and services in the economy. However, in practice, there are often discrepancies due to statistical discrepancies, changes in inventories, and the underground economy.