What is Gross Domestic Income (GDI) vs Gross Domestic Product (GDP)?
Gross Domestic Income (GDI)
Gross domestic income (GDI) is a measure of total economic activity. It is based on all the income earned while producing goods and providing services through economic activity.
Key Points
- Gross domestic income (GDI) is a measure of U.S. economic activity. It is based on all the income earned while engaged in producing all the goods and services. It includes everything that constitutes that economic activity.
- GDI calculates total income that is paid to produce gross domestic product (GDP).
- Income equals Spending – A fundamental concept in macroeconomics is that income equals spending. Simply put, an economy at equilibrium will show that GDI is equal to GDP.
Measures Total Economic Activity
Gross Domestic Income (GDI) is a less used measure of total economic activity. It is similar to Gross Domestic Product (GDP). Both figures measure the value of all production in a year, so their final totals are virtually identical. The main difference between the two is how thay arrive at their destination. GDP measures the total value of what was purchased. GDI measures the total value of payments to those who made or sold it. The two values tend to be within one percent of each other,
GDI is a very useful measure for determining how Americans earn their incomes and maintain their standards of living. Measuring income in this way offers distinct advantages. Unlike almost any other income data, it is complete. It adds up to the total value of all economic production with nothing missing. The Bureau of Economic Analysis (BEA) has put together data on American GDI going back to the start of the Great Depression. This makes GDI a very long-running metric to study, evaluate and compare.
Understanding Gross Domestic Income (GDI)
The Federal Reserve Bank uses both Gross Domestic Income (GDI) and Gross Domestic Product (GDP). These two measures represent the total economic activity in the United States.
A fundamental concept in the field of macroeconomics holds that income equals spending in a static economy. In other words, the money spent buying what was produced must equal the source of that money. GDI measures total economic activity based on the income paid to produce total output. GDP, on the other hand, values production by the amount of output that is purchased. Put another way, GDI calculates the income that was paid to generate GDP. So, a static economy at equilibrium should see GDI equal to GDP. They are two sides to the same coin.
GDI= Wages + Profits + Interest Income+ Rental Income + Taxes− Subsidies on Production and Imports+ Statistical Adjustments
GDP= Consumption + Investment+ Government Purchases + Exports− Imports
Wages represent the total compensation paid to employees for the goods and services they provide. Profits, also called gross operating surplus, refers to the financial gain realized by incorporated and unincorporated businesses. Statistical adjustments may include corporate income tax, dividends, and undistributed profits.
Employee Compensation
One important metric is the ratio of wages and salaries to GDI. The BEA compares this ratio with corporate profits as a share of GDI to see where the constituents, mainly workers and company owners, stand relative to each other with respect to claims on GDI. Workers’ share should be higher when unemployment is low, but recent evidence shows that is not necessarily the case, which is puzzling to economists. Employee compensation to GDI is also compared with inflation trendlines. Economists look for signs of a positive correlation between a higher ratio of the former with an upward bias in the latter. (Source: investopedia.com)
What is Real Gross Domestic Income (Real GDI)?
Real gross domestic income (real GDI) measures purchasing power. Real GDI reflects total income generated by domestic production, but includes changes in the terms of trade. It is equal to gross domestic product at constant prices plus or minus trading gains or losses. People want to know whether the total output of goods and services is growing or shrinking. However, GDI and GDP are collected at current, or nominal, prices and wages. As a result, you cannot compare two periods without making adjustments for inflation. To determine real GDI, the nominal value must be adjusted to take into account price changes due to inflationary factors. This allows us to see why the value of output has gone up. Is it because more is being produced or simply because prices have increased?
A statistical tool called the price deflator is used to adjust GDP from nominal to constant prices. To get the real GDP and real GDI, the Bureau of Economic Analysis (BEA) removes the effects of inflation. This allows economists to compare figures from different years. Without this adjustment, it might seem like the economy is growing when it’s actually suffering from double-digit inflation. The BEA calculates real GDP by using a price deflator, which indicates how much prices have changed since a base year.
How Gross Domestic Income (GDI) Affects You
GDI and GDP impact personal finance, investments, and job growth. Investors look at a nation’s growth rate to decide if they should adjust their investment portfolios. The Federal Reserve, the central bank in the U.S., uses the growth rate to determine monetary policy. Keeping track of the nation’s growth rate can help investors predict what the Fed is likely to do.
- Interest Rates – The Fed expands monetary policy to ward off recession and constricts monetary policy to prevent inflation. Its primary tool is the federal funds rate. For example, if the growth rate is increasing, then the Fed raises interest rates to fight off inflation. The federal funds rate influences most of the interest rates that affect consumers and borrowers. It affects their mortgages, personal loans and yields on their savings accounts.
- Unemployment – If growth slows or becomes negative, then you might want to update your resume. Low economic growth leads to layoffs and unemployment. It may take a few months to see the corresponding job loss. This is because it takes time for the effects to be felt. As business dwindles, companies compile layoff lists. When economic growth slows, it’s inevitable for many companies to cut costs and jobs. Unemployment is considered a lagging economic indicator. This is because there is a delay between economic growth rates and the impact on individual jobs.
- Opportunities During Downturns – The BEA offers breakdowns of GDP data that examine specific sectors and products. You can use these details to determine which sectors of the economy are growing and which are declining. Even during hard economic times, particular sectors continue to add jobs, such as the health care industry during the 2008 financial crisis.
Leading Indicator for Economic Size and Growth
GDP is important because it gives information about the size of the economy and how an economy is performing. The growth rate of real GDP is often used as an indicator of the general health of the economy. In broad terms, an increase in real GDP is interpreted as a sign that the economy is doing well. When real GDP is growing strongly, employment is likely to be increasing as companies hire more workers for their factories and people have more money in their pockets.
When GDP is shrinking, as it did in many countries during the recent global economic crisis, employment often declines. In some cases, GDP may be growing, but not fast enough to create a sufficient number of jobs for those seeking them. But real GDP growth does move in cycles over time. Economies are sometimes in periods of boom, and sometimes in periods of slow growth or even recession (with the latter often defined as two consecutive quarters during which output declines). In the United States, for example, there were six recessions of varying length and severity between 1950 and 2011. The National Bureau of Economic Research makes the call on the dates of U.S. business cycles. (Source: InternationalMonetaryFund.org)
GDI vs GDP – Two Sides of the Same Coin
Every market exchange is a two-way process. The buyer trades money for a good or service. The seller trades a good or service for money. As a result, the total value of goods traded can be identified from either side of the market exchange. The total economic activity can be measured from the expenditure made by the buyer or from the income received by the seller.
The overall value of production, which is what GDP seeks to measure, is determined mutually by buyers and sellers through such market exchanges. On one side of market exchanges is the suppliers, producing and selling goods. On the other side is demanders, purchasing and using goods. For each good sold, someone buys. For each good bought, someone sells. The number crunchers at the Bureau of Economic Analysis use this two-sided notion to derive a relatively accurate estimate of total production (that is, gross domestic product) using total income. (Source: amosweb.com)
GDP uses the expenditure approach to determine to gross domestic product. GDI uses an income approach to measure gross domestic income. In a perfect and static world, gross domestic product and gross domestic income are EXACTLY equal. However, that would require every calculation to be accurate, no mistakes to be made made, and all production and income to be correctly identified. But, the world we live in is not perfect or static. As a result, there is almost always some discrepancy between these two approaches. The good news is this discrepancy is generally quite small, less than 1 percent of GDP.
Problems With GDI and GDP Measurements
The GDI and GDP are designed to measure the market value for all products and services within a country’s borders. Since the measurement relies on using market prices, there are many transactions that are left out of the GDP numbers.
- Environmental costs – One of the biggest criticisms of GDP it that it doesn’t count environmental costs. For example, the price of plastic is low because it doesn’t include the cost of pollution. GDP doesn’t measure how these costs impact the well-being of society. A more accurate measurement of a country’s standard of living may include environmental conditions.
- Unpaid Services – GDP calculations don’t include unpaid services. For example, it leaves out unpaid child care and volunteer work. This is despite the positive impact these two activities might have on the economy and quality of life.
- Black Market Economy – GDP also does not account for the shadow market or black economy. This omission underestimates economic output. Especially in countries where many people receive income from illegal activities. These products aren’t taxed and don’t show up in any government records. Governments can estimate, but they cannot accurately measure this output. The Bureau of Labor Statistics estimates the shadow economy’s size as 8.8% of the GDP.
What GDI and GDP do not Reveal
It is also important to understand what GDI cannot tell us. GDI and GDP are not a measure of the overall standard of living or well-being of a country. In general, positive changes in the output of goods and services per imply that there is growth and that’s a good thing. But, GDI does not measure whether the average citizen in a country is better or worse off. It does not capture things that may be deemed important to general well-being.
So, for example, increased output may come at the cost of environmental damage or other external costs such as noise. Or it might involve the reduction of leisure time or the depletion of nonrenewable natural resources. The quality of life may also depend on the distribution of GDP among the residents of a country, not just the overall level. To try to account for such factors, the United Nations computes a Human Development Index, which ranks countries not only based on GDP per capita, but on other factors, such as life expectancy, literacy, and school enrollment. Other attempts have been made to account for some of the shortcomings of GDP, such as the Genuine Progress Indicator and the Gross National Happiness Index, but these too have their critics. (Source: InternationalMonetaryFund.org)
