Aggregate income refers to the value of all income that suppliers of production factors receives over a specified period. The value will be equal to the value of aggregate output because it ultimately flows to the owner of the factors of production.
Why is aggregate output equal to aggregate income?
Aggregate output, aggregate income, and aggregate expenditure, in principle, are for measuring the same metric. So, theoretically, the value of all three must be equal.
But, indeed, in reality, the three gave slightly different values. That’s not because the concept is wrong, but rather due to differences in the data availability and data collection methods. Hence, the central bureau of statistics often uses additional metrics, namely, statistical discrepancies.
Back to “the question why all three are the same.” Let’s take a straightforward example. Like a country, it consists of only two households and one business. One household works as an employee (household A) and another as an entrepreneur (household B).
Say, a business produces an output of 100 units at Rp10 each. In other words, the aggregate output is Rp1,000 (100 x Rp10).
The business then sells 8 items to household B (the entrepreneur) and the rest to household A. The entrepreneur spends IDR 80 (8 x IDR 10). Meanwhile, employees spend money worth Rp20 (2 x Rp10). So, the total expenditure for both of them is Rp1,000, equivalent to aggregate spending.
Then, from the sale, the business uses it to pay wages and make a profit. Assume the company doesn’t pay dividends and use capital. The business pays a salary of Rp20, and the remainder is the company’s profit. So, total income (labor and company) is equal to Rp1,000.
The example is indeed simple, and in the real world, the calculation is complicated. Economic activities don’t only involve households and businesses, but also the government. When a country is an open economy, it also includes foreigners (and consists of households, businesses, and governments).
In the example above, some notes might be your question. Households may not buy from domestic businesses, but abroad. Likewise, a business might sell its products overseas rather than domestically.
Finally, households may not spend their income on consumption instead, save it. Also, they have to pay taxes, so their income is not just for consumption and savings.
Yes, it is true. I made the example above just to make it easier to explain the concept.
What is the formula for calculating aggregate income
The aggregate income component consists of:
- Employee compensation – including wages and benefits such as pension plans and health insurance paid by employers
- Profit by business– some of the profits go to shareholders (dividends). The rest is retained in the company (retained earnings).
- Rental income – payments for the use of the property (land).
- Interest income – payments for loanable funds provided.
- Government revenue minus subsidies
Then, you can calculate aggregate income with the following formula:
Aggregate income = Employee compensation + Rental income + Interest income + Business profit + Government revenue less subsidies
In some textbooks, you might find a different formula. Because it must be the same as the aggregate expenditure, the author may use the formula: C + S + T;
- C is consumption expenditure
- S is household and business savings
- T is a net tax (tax payment minus transfer payment)
Consumption plus savings are equivalent to income received by households or businesses. Why? That’s because households spend their income on consumption and savings.
For businesses, their consumption covers expenses such as capital expenditure, dividend payments, wages, and other operational costs. The rest is retained earnings, which is the profit that the business holds as capital (act as business savings).