The income approach to measuring gross domestic product (GDP) is based on the accounting reality that all expenditures in an economy should equal the total income generated by the production of all economic goods and services. It also assumes that there are four major factors of production in an economy and that all revenues must go to one of these four sources. Therefore, by adding all of the sources of income together, a quick estimate can be made of the total productive value of economic activity over a period. Adjustments must then be made for taxes, depreciation, and foreign factor payments.

Ways to Calculate GDP

There are generally two ways to calculate GDP: the expenditures approach and the income approach. Each of these approaches looks to best approximate the monetary value of all final goods and services produced in an economy over a set period of time (normally one year).

The major distinction between each approach is its starting point. The expenditure approach begins with the money spent on goods and services. Conversely, the income approach starts with the income earned (wages, rents, interest, profits) from the production of goods and services.

Formula for Income Approach

It's possible to express the income approach formula to GDP as follows: Total National Income + Sales Taxes + Depreciation + Net Foreign Factor Income. Total national income is equal to the sum of all wages plus rents plus interest and profits.

Some economists challenge the notion of including sales taxes in the GDP formula on the basis that taxation is counterproductive. They think it should subtract from total output rather than add to it. However, most people use the income approach that includes sales taxes.