The income method of calculating GDP is based on the idea that the total value of all goods and services produced in an economy is equal to the total income earned by all factors of production, such as labor, capital, land, and entrepreneurship. In other words, GDP is the sum of all wages, rent, interest, and profits in the economy.
To calculate GDP using the income method, we need to make some adjustments to the total national income (TNI), which is the sum of all income received by the factors of production. The adjustments are:
Add sales taxes (T), which are taxes imposed by the government on the sales of goods and services. These taxes are not part of the income earned by the factors of production, but they are part of the final value of the goods and services.
Add depreciation (D), which is the cost allocated to a tangible asset over its useful life. Depreciation reflects the decrease in value of capital goods due to wear and tear or obsolescence. Depreciation is not an actual payment, but it is an accounting expense that reduces the profits of firms.
Add or subtract net foreign factor income (F), which is the difference between the income earned by domestic factors of production in foreign countries and the income earned by foreign factors of production in the domestic country. Net foreign factor income can be positive or negative, depending on whether the domestic country has a surplus or a deficit in its factor income account.
The formula for GDP using the income method is:
textGDP=textTNI+textT+textD+textF