Why is depreciation added to Gross domestic product and removed while calculating net domestic product?. Unable to understand about those two concepts. Can someone please explain them clearly.
Though it is technically referred to as a Capital Consumption Allowance (CCA) in GDP accounting, depreciation is the right way to think about it conceptually. And though the analogy is not perfect, the connection between GDP, CCA and Net Domestic Income—NDI (what I believe you’re referencing as net domestic product) is very akin to the relationship among cash flow, depreciation and net income in a business operation.
NNI and CCA arise when discussing GDP from the income-based approach rather than the expenditure approach (i.e. C + I + G + X – M). In theory the two approaches arrive at the same value for economic output (one person’s expenditure is another person’s income).
NNI includes business profits, but naturally business cash flow exceeds profits by the non-cash expenses that are deducted when determining taxable income. To account for the economy-wide cash flow received by small and large businesses, among other income recipients (i.e. GDP), it is necessary to account for any cash flows not subject to taxation (i.e. CCA).
Of course, the CCA is not income, that is why it is deducted from GDP when determining NNI.
A final thought to help clarify the CCA by considering it from another perspective: think of the CCA as the amount businesses would have to invest to maintain the economy’s current productive capacity (i.e. potential GDP).
@Analyst0718, you mean the depreciation is not there in the net operating income in the income approach,yet if I consider gross operating income then I wouldn’t add depreciation right?
I’m not sure what you mean by net operating income? Never heard the term. There is Net income or operating income, and those are accounting concepts. Not sure what you’re referring to here specifically.