Question

     1.   List and explain the two different approaches used to measure GDP.

     2.   Explain why GDP figures do not necessarily measure happiness or well-being.

     3.   Given that GDP is a measure of what is produced in a country, explain how the expenditure approach can measure GDP. How are items produced, but not yet sold, accounted for in the expenditure approach?

Answer 1

1.Two different methods of measuring GDP are:

Expenditure Method. It invoves computing GDP by adding up the dollar value at current market prices of all final goods and services. The Formula is GDP = C + I + G + X, where,

C is Consumption Expenditure. It includes durable consumer goods -- items that last more than 3 years, nondurable consumer goods -- goods that are used up in 3 years and services -- mental or physical help.

I is Gross Private Domestic Investments. It includes the creation of capital goods, such as factories and machines, that can yield production and hence consumption in the future. It also includes changes in business inventories and repairs made to machine and buildings.

G is Government Expenditures. It includes state, local or federal expenditure made by government and is valued at cost.

X is Net Exports.It includes Net Exports. The Net Exports are calcualted by deducting total import of goods and services from total exports.

Income Method. The income approach to calculating GDP measures the value of all final goods and services in an economy using the income they generate. National income is the sum of wages (and other labor compensation), rent, interest, and profits.The final numbers will be the same in the income approach and in the expenditures approach (income will equal expenditures). But the income approach provides a different perspective on the economy. The expenditures approach tells us "who bought what." The income approach tells us "who earned what."

GDP = National Income + Indirect Business Taxes + Net Foreign factor income + depreciation

National Income = Rent +Wages + Interest + Profits and Losses

Rent is obtained from land. Wages are eaned by labor. Labor compensation dominates national income. Interest is paid or earned on Capital. Profit and losses relate to Enterpreneur ability. These include Properitor's Income which is Profits and losses earned by individual proprietors. Capital Income is Profits and losses of corporations (as opposed to those of individual proprietors). Indirect Business Taxes are Taxes paid by businesses, such as property taxes, sales taxes, excise taxes, license fees, and tariffs. These taxes are paid by firms and then are passed on to consumers as part of the price of the good or service produced. Indirect business taxes are differentiated from corporate income taxes on business profits. Net Factor Income from Abroad is the difference between payments received from resources owned in foreign countries and income earned by people in foreign countries from resources owned domestically.

2. GDP is a measure of well being but it is a rough measure. Following are certain flaws related to GDP:

• It does not present the true picture of well being and standard of living. For Example GDP per Capita of US is higher than Germany. This does not mean people in US are more happy than in Germany. It faisl to measure the leisure time spent by people with their families or going on vacations. Standard of Living and well being cannot be measured in monetary terms.
• GDP can tell the amount spent on education, environment cleansing and healthcare. But it cannot tell the result of these activities. It cannot tell how many people have actually become lierate. It cannot tell how much environment is purified and how much pollution is reduced. It cannot tell how much the mortality rate has declined or life expectancy has increased.
• It is a misleading indicator of well being. For example In a certain country people have to install theft alarms due to growing crime and robberies. No doubt GDP will increase by production of more theft alarms but this points out towards the deteriorating standard of living as people are always afraid of theft and crime.
• GDP has nothing to say about the level of inequality in society. GDP per capita is only an average. When GDP per capita rises by 5%, it could mean that GDP for everyone in the society has risen by 5% or that the GDP of some groups has risen by more while the GDP of others has risen by less—or even declined.

To conclude it is a limited tool for measuring well being. It includes only goods that are bought and sold in market. Happiness of people cannot be bought and sold in market.

3. GDP is the sum total of the final value of goods and services produced in a country during a particular period of time. The expenditure approach to calculating gross domestic product (GDP) takes into account the sum of all final goods and services purchased in an economy over a set period of time. That includes all consumer spending, government spending, business investment spending, and net exports. Quantitatively, the resulting GDP is the same as aggregate demand. The expenditure approach begins with the money spent on goods and services. It includes the amount of money spent by buyers of final goods and services. GDP includes both tangible goods and intangible services.

GDP = C + I + G + (X - M)

where:

C=Consumer spending on goods and services

I=Investor spending on business capital goods

G=Government spending on public goods and services

X=Exports M=Imports​

Inventory Investment is a part of Investments . It includes changes in the stock of unsold goods.Goods produced but not yet sold are included in inventory investments. All goods produced are included in GDP, if they are not sold, they are counted in I (Investment) category.