Gross National Product: The Income Side of GNP

The Income Side of GNP As we showed in Chapter 5, expenditure on output in product markets provides the funds for business firms to meet such expenses as wages, interest, and rents. Aggregate expenditure on final products becomes the aggregate income of the nation. Therefore, GNP not only measures aggregate expenditure, it also measures aggregate income! Every dollar spent on final products produced during the year ends up as income to either businesses or households. The total income generated from production of final products is therefore equal to the value of those final products which, as you saw in the previous section, is also equal to the value added to intermediate products by productive resources in the nation. Real GNP represents the value of final products produced during the year after adjustment for inflation. You can now see that real GNP also represents the aggregate real income of a nation, which is its nominal (money) income adjusted for inflation since the base year used to measure real GNP. If real GNP falls, so will aggregate real income. If income, and living standards, in a nation are to grow, real GNP must also grow. One of the reasons economists are so concerned about gross national product and its rate of growth is that production generates income. The more production in a given year the more jobs. More jobs mean more income for workers. Dividing GNP into Income Components Who earns the income that results from the production of goods and services in the economy? How much of that income is saved? How much goes to pay the taxes that finance government purchases and government transfer payments? The National Income and Product Accounts help us answer questions like these by keeping tabs on the way our aggregate expenditure on goods and services is channeled through the economy to businesses, resources owners, and governments. Let's examine the income side of GNP by tracing out the uses of the receipts businesses take in during the year. Some of the receipts of business firms are used to pay sales taxes on output, such as gasoline taxes and state and local sales taxes, and some is plowed back into the businesses to finance investment. Most of the remainder is paid out as wages and salaries, interest on borrowings, and rents. Whatever is left over after making these payments is the profit of business enterprises. The income components of GNP show how the receipts of business firms are allocated to pay for the resources used to produce final products during the year. The major income components of GNP are discussed below. 1. Compensation of employees. Employee compensation is the income from the sale of labor services during the year. Included in the compensation of employees are wages, salaries, and fringe benefits, such as employer-provided insurance and employer contributions to pension funds. Compensation of employees is the labor cost of producing final products and is by far the largest income component of GNP. It accounts for about 60 percent of the value of final products produced each year. 2. Net interest. The portion of business receipts used to pay for borrowed funds that finance investment purchases is called net interest. These interest payments provide earnings for savers and other suppliers of loanable funds for investment purchases. Interest paid by governments is not included in this category because it is financed by taxes rather than out of revenue from the sale of final products. Net interest accounted for 8.6 percent of GNP in 1989. 3. Rental income. Rental income is earned by those who supply the services of land, mineral rights, and buildings for use by others. Also included in rental income is an estimate of the imputed rent earned by homeowners who live in their own homes less the expenses of maintaining their homes. Rental income accounts for only a small fraction of GNP-only 0.2 percent in 1989. 4. Profits. Before we can calculate the profit of corporations and unincorporated businesses, we have to make two additional deductions from business receipts in addition to payments for use of productive resources discussed: a) Indirect business taxes. Taxes levied on the sales of final products that are reflected in the market value of goods and services sold by business firms are called indirect business taxes. These taxes include sales taxes, excise taxes, other taxes that business firms treat as costs. Indirect business taxes account for about 8 percent of the value of receipts taken in from the sale of final products each year. They are really the portion of the receipts collected by business firms that are claimed by governments rather than used to pay for input costs or to be included as profit. b) Capital consumption allowances. A surprisingly large portion of the receipts from the sale of final products are set aside by business firms as capital consumption allowances (depreciation). As we pointed out in our discussion of investment, the capital consumption allowance accounts roughly for the value of capital goods that is "used up" in production during the year. Capital consumption allowances average nearly 11 percent of GNP and represent the second largest use of business receipts after payment of compensation of employees. Capital consumption allowances are a major portion of business saving, which represents business receipts that are neither paid out to resource owners nor used to pay taxes or to add to profits. After deductions from business receipts for indirect business taxes and capital consumption allowances, and costs for compensation of employees, net interest, and rents paid, the remainder is profit. Profit represents the income earned by owners of unincorporated corporate business (proprietors income). Profit can be positive or negative. If costs exceed the receipts from the sale of final products, profit will be negative-implying that in the aggregate business firms incur losses during the year. As you know, the rate of profit is a very important determinant of the incentive firms have to supply goods and services. Profits accounted for 13.3 percent of GNP in 1989. The Economy's Income Statement For the national economy, we can use an income statement to show how receipts are allocated to pay expenses over a period. Such a statement shows how the receipts from expenditure on final products are accounted for by earnings of owners of resources and by other payments. Box 5 shows the income statement for the national economy in 1989. The value of final products represented by the sum C + I + G + NE must be accounted for as the flow of income and other payments generated by their sale. The left side of the income statement in Box 5 shows how GNP is measured by aggregate expenditures. The right side of the income statement shows how receipts taken in from sales of final products are allocated to reward resource owners and to fund capital consumption allowances and pay indirect business taxes. In effect, the economy is viewed as an enormous household in the NIPA. Aggregate expenditure must equal aggregate income.