Definitions of Income

Exist many definitions of Income

A student in college will count his income as the total money that he has available to spend during the year. This may include his summer earnings, earnings from a part-time job during the school year, and gifts received from his parents. The student's income is defined as money receipts available for expenditure.

A businessman will define income in a more complicated way. His gross income will consist of revenue from the sale of goods or services. Net income will measure what remains after meeting the expenses of producing the goods or services. In addition, the businessman will be required to compute his net taxable income as a basis for payments to the federal and state governments. This measurement will be affected by the tax statutes that are applicable to his business.

The economist's definition of income is closer to that of the businessman than to that of the student. The income definition used by an economist is based on the output of an economic system during a period of time. That is, the goods and services that are produced in a country (the output) during a period of time, such as one year, are matched by the income received from the production of those goods and services in that year. Thus, income consists of wages and salaries, interest, profits, and rent that are paid to those who contribute their labor services or who own the capital resources-plant and equipment-used in production.

One basic distinction runs through all definitions of income-the difference between real income and money income. To return to the example of the college student: suppose that he agrees to take care of the furnace and lawn at his rooming house in exchange for "free" rent. His money income is not increased, but his real income is larger, because he need pay no rent to his landlady. Therefore, to judge his "true" income position it will be necessary to count in the rental value of the room that he occupies.

The distinction between real and money income is also important in another context. The student's money income might remain constant during the year, but if he has to pay higher prices for meals, books, and supplies, the purchasing power of that money income would decline. Thus his real income would decline although his money income remained unchanged.

Flow Concept

In the economic analysis of income it is a basic truism that, for the economy as a whole, income equals output. Economic activity consists of the production of goods and services through time. This production gives rise to a flow of income to the factors of production- the land, labor, and capital that are used in the production process. This truism may be illustrated by an oversimplified example of a hypothetical XYZ manufacturing firm that rents its equipment and thus has no depreciation. It is also assumed in this example that the firm pays no sales or property taxes. At the end of the year the books of account might show:

The output of the XVZ firm consists of the product that it sold plus the product that it produced but which remained unsold-the net inventory change. This output is matched by the incomes that it generated. The numerical equality between the two sides of the account is main tained, for all business enterprises by the balancing role of profits. Thus, in the XYZ example, if employee compensation increased from ou to 65, but revenue from sales remained the same, profits would be lowered from 10 to 5.

Wealth as a Stock

The concept of income as a flow of economic activity requires that it be distinguished from wealth. The latter consists of the stock of a nation's assets, the existing resources that are employed in production. inese include the plant and equipment and raw materials used by business firms and the social capital represented by public investment in government buildings, schools, transportation facilities, and the like. The wealth of a nation also includes the housing and consumer durables owned by households. And the nation's wealth includes, perhaps most importantly, the investments that have been made in human resources, in the education and skills of the citizenry.

The distinction between wealth as a stock and income as a flow means that changes in the titles to any part of the stock of assets do not count as income. The purchase and sale of financial assets, such as stocks and bonds, represent a change in the ownership or title to existing assets, not an increase in those assets. Similarly, the purchase and sale of an existing house or of a plot of land are not income. For an increase in income to take place there must be an increase in output. Changes in the ownership of existing assets do not increase total output.