No Such Thing as a Free Lunch: Principles of Economics (Part 100)

Macroeconomics, even with all of our computers and with all of our information, is not an exact science and is incapable of being an exact science.

Paul Samuelson

Measuring National Output and National Income

(Part D)

by

Charles Lamson

From GDP to Disposable Personal Income

Although GDP is the most important item in national income accounting, other concepts are also useful to know. A country's GDP is total production by factors of production owned by that country. If we take U.S. GDP, add it to factor income earned by U.S. citizens from the rest of the world (receipts of factor income from the rest of the world), add and subtract from it factor income earned in the United States by foreigners (payments of factor income to the rest of the world), we get GNP.

From GNP we can calculate net national product (NNP). Recall that the expenditure approach to GDP includes gross investment as one of the components of GDP (and of GNP). Gross domestic product does not account for the fact that some of the nation's capital stock is used up in the process of producing the nation's product. NNP is GNP minus depreciation. In a sense, it is a nation's total product minus (or "net of") what is required to maintain the value of its capital stock. Because GDP does not take into account any depreciation of the capital stock that may have occurred NNP, is sometimes a better measure of how the economy is doing than is GDP.

To calculate national income, we subtract indirect taxes minus subsidies from NNP (subtract indirect business taxes and add subsidies). We subtract indirect taxes because they are included in NNP but do not represent payments to factors of production and are not part of national income. We add subsidies because they are payments to factors of production but are not included in NNP.

Personal income is the total income of households. To calculate personal income from national income, new items are subtracted: (1) corporate profits minus dividends, and (2) social insurance payments. Both need explanation. First, some corporate profits are paid to households in the form of dividends, and dividends are a part of personal income. The profits that remain after dividends are paid---corporate profits minus dividends---are not paid to households as income. Therefore, corporate profits minus dividends must be subtracted from national income when computing personal income. Second, social insurance payments are payments made to the government, some by firms and some by employees. Because these payments are not received by households, they must be subtracted from national income when computing personal income.

Two items must be added to national income to calculate personal income: (1) personal interest income received from the government and consumers, and (2) transfer payments to persons. As we have pointed out interest payments made by the government and consumers (households) are not counted in GDP and not reflected in national income figures. However, these payments are income received by households, so they must be added to national income when computing personal income. Households can pay and receive interest. As a group, households receive more interest than they pay. Similarly, transfer payments to persons are not counted in GDP because they do not represent the production of any goods or services. Social Security checks and other cash benefits are income received by households and must also be added to national income when computing personal income. 

Personal income is the income received by households before paying personal income taxes but after paying social insurance contributions. The amount of income that households have to spend or save is called disposable personal income, or after-tax income. It is equal to personal income minus personal taxes.

Because disposable personal income is the amount of income that households can spend or save, it is an important income concept. There are three categories of spending: (1) personal consumption expenditures, (2) interest paid by consumers in business, and (3) personal transfer payments to foreigners. The amount of disposable personal income left after total personal spending is personal saving. If your monthly disposable income $500 and you spend $450, you have $50 left at the end of the month. Your personal saving is $50 for the month. Your personal saving level can be negative: if you earn $500 and spend $600 during the month you have dissaved $100. To spend $100 more than you earn, you will either have to borrow the $100 from someone, take the $100 from your savings account, or sell an asset that you own.

The personal saving rate is the percentage of disposable personal income saved, an important indicator of household behavior. A low rate means households are spending a large amount of their income. A high saving rate means households are cautious in their spending. The U.S. personal savings rate in March 2021 was 27.6 percent (bea.gov. "Personal Saving Rate"), compared to the 2019 average of 7.6 percent (statista.com). Saving rates tend to rise during recessionary periods, when consumers become anxious about their future, and fall during boom times, as pent-up spending demand gets released. 

*CASE & FAIR, 2004, PRINCIPLES OF ECONOMICS, 7TH ED., PP. 399-401*

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