Question

1. Discuss the differences calculating GDP using the expenditure approach and income approach. Be specific, do not just write the formula.

Answer 1

The steps involved in calculating GDP by Expenditure method -

Step 1 Identify the economic units, which incur final expenditure within the domestic territory are classified under 4 groups: (i) Household sector (ii)Govenrnment sector (iii) Producing sector, (iv)rest of the world

Step 2 Classification of final expenditure

Final expenditures incurred by the above mentioned economic units are estimated and classified under the following heads:

* Private Final Consumption expenditure (PFCE)- It refers ti expenditure incurred by households and private non profit institutions serving households on all types of consumer goods .

* Government Final Consumption Expenditure (GFCE)- It refers to the expenditure incurred by general government on various administrative services like defence, law and order, education etc.

* Gross Domestic Capital Formation (GDCF)- It refers to the expenditure incurred on acquiring goods for investment by the production units located within the domestic territory.

* Net Exports (Export - Import) - It refers to the difference between exports and imports of a country during a period of one year

The sum of total of four components of final expenditure gives Gross domestic produc.

GDP= PFCE+GFCE+GDCF+ Net exports

According to income approach GDP can be calculated by total national income

Steps involved in calculating GDP by Income method -

Step 1 Identify and classify the production units

All the producing enterprises employing various factors of production are identified and classified into primary, secondary and tertiary sectors.

Step 2 Estimate the factor income paid by each sector classified under following heads-

*Compensation of employees(COE) - Compensation of employees refers to amount paid to employees by emolyer for rendering productive services. COE includes wages and salaries in cash, wages and salaries in kind and employer's contribution to social security schemes.

*Rent and royalty- Rent is the income which arises from ownership of land and building.

*Royalty refers to income received for granting leasing rights of sub soil assets.

*Interest - Interest refers to amount received for lending funds to a production unit.

*Profit- Profit is the reward to the entrepreneur for his contribution to the production of goods and services. Profit includes Corporate tax, Dividend and Retained earnings.

*Mixed income - It is income generated by own-account workers (like farmers, barbers etc.) and unincorporated enterprises (like retail traders, small shopkeepers, etc.).

Step 3 Calculate National Income

National Income  = Compensation of employees + Rent and royalty + Interest + Profit + Mixed Income

Step 4 Convert National income to GDP by adding Sales tax, Depreciation and Net foreign factor inome to GDP.

GDP= National income+ Sales tax+ Depreciation + Net foreign factor income