For economists trying to measure the health of an economy, there are a number of similar sounding but slightly different concepts that can confuse those without a background in macroeconomics. Two of these such terms are aggregate output and aggregate income, two key concepts that are similar but subtly different. Let's walk through it.
How much is an economy actually producing?
To understand the difference between aggregate output and aggregate income, we need to start at the top -- economic productivity, or GDP. Most countries use the United Nations' standardized formula ...
... where "Y" is GDP, "C" is consumption, "I" is investment, "G" is government spending, and ("X-M") is net exports. Of these components, consumption is the normally the largest, and the U.S. economy is no different.
GDP is a critical measure for politicians, policymakers, and economists, as increasing productivity creates jobs, increases wealth, and improves the quality of life for citizens.
Two concepts, one metric
Economists define aggregate output to be the sum of all the goods and services produced in an economy over a certain period of time. In other words, aggregate output is defined as an economy's total productivity, or GDP. By definition, then, aggregate output and GDP go hand in hand, with GDP acting as the practical application of the theory of aggregate output.
But there are other theoretical ways to define an economy's output. You guessed it -- aggregate income is one such way.
Aggregate income is defined as the total income earned by individuals and companies in the economy. Aggregate income excludes any adjustment for inflation and taxes. If aggregate output measures all of the goods and services produced in an economy, aggregate income measures how much money individuals and businesses actually make.
We can break down the definition of aggregate income to match the formula for GDP and see that these two concepts ultimately describe the same thing. First, let's assume that consumption as a percentage of income is constant. If that assumption is true, which most economists agree it is, then consumption will also be a certain percentage contributor to aggregate income.
Because aggregate income excludes any adjustment for taxes, it's also reasonable to add in government spending, as we see in the GDP formula. Governments tend to spend what they collect, after all.
Thinking through the formula further, aggregate income includes the net profits of an economy's businesses. That should roughly approximate to the business sector's investment and its net export figure.
Complex economies, complex theories, and an easy metric to make sense of it all
GDP doesn't perfectly fit either of the two concepts here, but it does do a good job approximating both. This makes sense conceptually, as aggregate output and aggregate income each describe the wealth building engine of an economy. One, aggregate output, describes the problem from a productivity standpoint, while the other, aggregate income, tackles the problem through incomes.
At the end of the day, it's two sides of the same coin.
The $15,978 Social Security bonus most retirees completely overlook
If you're like most Americans, you're a few years (or more) behind on your retirement savings. But a handful of little-known "Social Security secrets" could help ensure a boost in your retirement income. In fact, one MarketWatch reporter argues that if more Americans knew about this, the government would have to shell out an extra $10 billion annually. For example: one easy, 17-minute trick could pay you as much as $15,978 more... each year! Once you learn how to take advantage of all these loopholes, we think you could retire confidently with the peace of mind we're all after. Simply click here to discover how you can take advantage of these strategies.
This article is part of The Motley Fool's Knowledge Center, which was created based on the collected wisdom of a fantastic community of investors based in the Foolsaurus . Pop on over there to learn more about our Wiki and how you can be involved in helping the world invest, better! If you see any issues with this page, please email us at knowledgecenter@fool.com . Thanks -- and Fool on!
The article Aggregate Output vs. Aggregate Income originally appeared on Fool.com.
Try any of our Foolish newsletter services free for 30 days . We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy .
Copyright © 1995 - 2016 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy .
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
