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- [woman] What is
the "factor income approach"?
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It describes one approach
to calculating GDP through income.
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Also known
as the "income approach,"
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the factor income approach
measures GDP
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by adding up employee compensation,
rent, interest, and profit.
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Now this may seem a little bit odd.
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Didn't we define GDP
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as the market value
of final goods and services?
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How can we measure it
by looking at incomes?
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The reason is that
when a consumer spends money
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on final goods and services,
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that money ultimately
is received by someone --
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namely by workers, landlords,
lenders, and entrepreneurs.
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So we can measure GDP
by looking at the spending
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or the other side of the ledger --
by looking at the receiving.
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Now, in practice, there are
some tricky accounting issues,
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such as what to do
about sales tax and depreciation,
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but we're going to leave that
to the accountants.
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The basic idea here
is that we can compute GDP
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by looking at the spending
or the receiving,
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and, in fact, we do both.
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When we calculate GDP
by the factor income approach,
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by adding up employee compensation,
rent, interest, and profit,
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we call it "gross domestic income,"
or GDI.
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Why the different name?
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Well, in theory, GDP and GDI
are exactly equal.
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But since they're calculated
in very different ways,
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they usually give
slightly different results,
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hence the different names.
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Let's take a look
at the FRED database.
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Here we graphed GDP and GDI.
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Hard to see a difference, right?
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But zoom in a little bit, however.
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We can now see
that they're not perfectly identical,
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and in a recession, economists
often look at both figures
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since one of them
might sometimes give us
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an earlier or more accurate picture
of the economic situation.
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Keep in mind, however,
the key idea.
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We can split or measure GDP
in many different ways,
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depending on the questions
we're asking.
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Regardless of what
we choose to measure,
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GDP is always the market value
of all finished goods and services
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produced within a country in a year.
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If you want to learn more
about GDP, click here.
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Or, if you want to test yourself
on the factor income approach,
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click here.
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