Question

1. Write down the equation used to represent the relationship between GDP and the four major components of expenditures in GDP, then briefly explain each component.

2. Using a graph of the market for loanable funds, briefly explain the effects of each of the following on the real interest rate, saving, and investment.

(a) A decrease in government spending

(b) An increase in the expanded profitability of new investment in plant and equipment

Answer 1

1. GDP is the market value of final goods and services produced within the domestic territory of a country during one year. Components of GDP are Consumption expenditure, investment spending, government expenditure and net exports.

GDP = C + I + G + NX

a) Private Final Consumption Expenditure (C): It refers to expenditure on final goods and services by the individuals, households, and non-profit private institutions serving society. It includes: consumer services, consumer non durable goods and consumer durable goods.

b) Government final consumption expenditure (G): It refers to expenditure on final goods and services by the Government like expenditure on purchase of goods for consumption by the defence personnel.

c) Investment expenditure (I): It refers to expenditure on final goods and services by the producers. Example: expenditure by the farmers on the purchase of tractors or thrashers. It includes fixed investment and inventory investment.

d) Net exports (NX) refers to the difference between exports and imports during an accounting year. Exports are an expenditure by the foreigners on the domestically produced final goods and services while imports are an expenditure on the goods and services produced abroad.