Comparing GDP, National Income, Personal Income, and Personal Disposable Income

GDP

GDP stands for Gross Domestic Product. It refers to the market value of all goods and services produced within an economy in a given period of time. Equivalently, GDP also refers to the total income earned by each household, company, and government within a given period of time. Therefore, GDP measures the flow of personal income and output in an economy.

GDP Using the Expenditure Approach

GDP = Consumer spending on goods and services (C)

+ Business gross fixed investment (I)

+ Change in inventories (I)

+ Government spending on goods and services (G)

+ Government gross fixed investment (G)

+ Exports – Imports (X − M)

+ Statistical discrepancy

Exam tip: The easiest way to remember this formula is the following:

GDP = C + I + G + (X – M)

GDP Using the Income Approach

Using the Income Approach, Gross Domestic Product (GDP) is estimated as:

GDP = Gross Domestic Income (GDI)

= Net domestic income + Consumption of fixed income (CFC) + Statistical discrepancy

Note that the statistical discrepancy is equal to gross domestic product less gross domestic income.

Gross domestic income refers to the income received by all factors of production employed in generating the final output. It is calculated as follows:

Gross Domestic Income = Compensation of employees

+Gross mixed income

+Gross operating surplus

+Taxes less subsidies on production

+Taxes less subsidies on products and imports

Personal income refers to the broad measure of household income. As such, it measures the purchasing power of consumers. It consists of all the income either earned or not earned by households. It can be calculated as follows:

Personal Income = National Income

– Indirect business taxes

– Corporate income taxes

– Undistributed corporate profits

+  Transfer payments.

Personal disposable income refers to personal income minus taxes at a personal level. It measures the amount of net income that remains after households have paid all their tax levies. It also represents the amount households will spend on goods and services or will save to invest.

Therefore, household savings equals personal disposable income (PDI) minus consumption expenditures, interest paid to businesses, and personal transfer payments.

Question

Assume that the national account of a small island for 2018 showed that the government had received $15 million as revenue and spent $2 million on purchases and expenditure. National investment stood at $4 million, while the island recorded $10 million worth of export with a $5 million worth of import. If the consumption expenditure on final goods and services by consumers for that year amounted to $8 million, the  GDP for that year is closest to:

1. $11 million
2. $19 million
3. $34 million

Solution

The correct answer is B.

GDP = C + I + G + (X – M)

C = Consumption expenditure = $8 million

I = Investments = $4 million

G = Government purchases = $2 million

E = Exports = $10 million

M = Imports = $5 million

Thus, GDP = 8 + 4 + 2 + (10 – 5) = $19 million