Income approach
GDP = R + I + P + SA + W
here
R: Rents or Rental income - the income that landlords receive, including the imputed rent that homeowners “pay’’ to themselves, less expenses, such as depreciation.
I: Interests or Net interest - the interest domestic businesses pay minus the interest they receive, plus interest earned from foreigners
P: Profits includes Proprietors’ income (the income of noncorporate businesses, such as small farms, mom-and-pop stores, and law partnerships) and Corporate profits - the income of corporations after payments to their workers and creditors.
SA: Statistical Adjustments (corporate income taxes, dividends, undistributed corporate profits, depresiation, indirect taxes)
W: Wages or Compensation of employees - the wages and fringe benefits earned by workers.
NB! the mnemonic, "ripsaw"
GDP per capita: Gross domestic product per capita is the mean value of the output produced per person, which is also the mean income.
GDP per Capita and welfare
GDP per capita (per person) is often used as a measure of a person's welfare. Countries with higher GDP may be more likely to also score highly on other measures of welfare, such as life expectancy.
However, there are serious limitations to the usefulness of GDP as a measure of welfare:
Measures of GDP typically exclude unpaid economic activity, most importantly domestic work such as childcare. This leads to distortions; for example, a paid nanny's income contributes to GDP, but an unpaid parent's time spent caring for children will not, even though they are both carrying out the same economic activity. The value estimation of the goods and services that have no market price is called an imputed value.
Imputations are especially important for determining the value of housing. The Department of Commerce estimates what the market rent for a house would be if it were rented and includes that imputed rent as part of GDP. This imputed rent is included both in the homeowner’s expenditure and in the homeowner’s income.
Imputations also arise in valuing government services. For example, police officers, firefighters, and senators provide services to the public. Giving a value to these services is difficult because they are not sold in a marketplace and therefore do not have a market price.The national income accounts include these services in GDP by valuing them at their cost.That is, the wages of these public servants are used as a measure of the value of their output.
No imputation is made for the value of goods and services sold in the underground economy.The underground economy is the part of the economy that people hide from the government either because they wish to evade taxation or because the activity is illegal.
GDP takes no account of the inputs used to produce the output. For example, if everyone worked for twice the number of hours, then GDP might roughly double, but this does not necessarily mean that workers are better off as they would have less leisure time.
Comparison of GDP from one country to another may be distorted by movements in exchange rates. Measuring national income at purchasing power parity may overcome this problem at the risk of overvaluing basic goods and services, for example subsistence farming.
GDP does not measure factors that affect quality of life, such as the quality of the environment (as distinct from the input value) and security from crime. This leads to distortions - for example, spending on cleaning up an oil spill is included in GDP, but the negative impact of the spill on well-being (e.g. loss of clean beaches) is not measured.
GDP is the mean (average) wealth rather than median (middle-point) wealth. Countries with a skewed income distribution may have a relatively high per-capita GDP while the majority of its citizens have a relatively low level of income, due to concentration of wealth in the hands of a small fraction of the population.
Because of this, other measures of welfare such as the Human Development Index (HDI), Index of Sustainable Economic Welfare (ISEW), Genuine Progress Indicator (GPI), gross national happiness (GNH), and sustainable national income (SNI) are used.