Question

 

a) Give the definition of GDP and explain what items are not included in its calculation?

b) How is GDP calculated using the expenditure approach?

c) How is GDP calculated using the income approach?

 

Answer 1

(a) Gross domestic product (GDP) is define as the market value of all the final goods and services produced within the domestic territory of a country's borders in a specific time period. As a broad measure of overall domestic production, it functions as a comprehensive scorecard of a given country’s economic health.

Items are not included in its calculation of GDP are :

Non-production transactions: Public transfer payments, such as Social Security, private transfer payments, such as gifts, and financial market transactions, since securities represent either ownership, such as with stocks, or they represent loans, such as bonds. Financial securities do not represent real production, but simply represent the means to finance production.

Illegal sales of goods and services (black marketing)

Any Transfer payments made by the government

Intermediate goods that are used to produce other final goods.

secondhand sales are excluded because no production is involved except for the sales service. For instance, goods sold in a consignment shop would not be part of the GDP, but the services provided by the consignment shop would be included.

(b) GDP calculated using the expenditure approach

The expenditure approach, also known as the spending approach, calculates spending by the different groups that participate in the economy.

This approach can be calculated using the following formula

GDP = C + G + I + NX

where, C = consumption (Consumption refers to private consumption expenditures)

  G = government spending (Government spending represents government consumption expenditure and gross investment)

I = Investment ( private domestic investment or capital expenditures )

NX = net exports (subtracting total exports from total imports (NX = Exports - Imports).

(c) GDP calculated using the income approach

The income approach calculates the income earned by all the factors of production in an economy, including the wages paid to labor, the rent earned by land, the return on capital in the form of interest, and corporate profits.

The income approach factors in some adjustments for those things that are not viewed as a payments made to made to factors of production. For one, there are some taxes, for example, sales taxes and property taxes—that are named indirect business taxes. Likewise, depreciation–a reserve that businesses put aside to represent the substitution of gear that will in general wear out with use–is additionally added to the public income.

GDP = Total National Income + Sales Taxes + Depreciation + Net Foreign Factor Income

Total National Income – the sum of all wages, rent, interest, and profits.

Sales Taxes – consumer taxes imposed by the government on the sales of goods and services.

Depreciation – cost allocated to a tangible asset over its useful life.

Net Foreign Factor Income – the difference between the total income that a country’s citizens and companies generate in foreign countries, versus the total income foreign citizens and companies generate in that country.