Question

Using illustrations and/data where applicable

Demostrate that GDP can be measured using two methods

Answer 1

Defining GDP : Gross domestic product is the market value of all the final goods and services produced within the national borders of a country for a given period of time.

GDP can be measured using the expenditure approach : Y=C+I+G+(X-M)

GDP can be determined by the summing up national income and adjusting for depreciation, taxes, and subsidies.

GDP can be determined in two ways, both of which, in principle, give the same result.

Gross Domestic Product (GDP) is the market value of all the final goods and services produced within the national borders of a country for a given period of time. GDP can be determined in multiple ways. The income approach and the expenditure approach highlighted below should yield the same field GDP number.

Simple view of expenditures : In an economy, households receive wages that they then use to purchase final goods and services. Since wages eventually are used in consumption (C), the expenditure approach to calculating GDP focuses on the end consumption expenditure to avoid double counting. The income approach, alternatively, would focus on the income made by household as one of its components to derive GDP.

GDP can be measured using two methods :

(i) EXPENDITURE APPROACH : The expenditure approach attempts to calculate GDP by evaluating the sum of all goods and services purchased in an economy. The components of U.S. GDP identified as "Y" in equation form, include Consumption (C), Investment (I), Government Spending (G) and Net Exports (X-M)

Y = C + I + G + (X-M) is the standard equation (expenditure) representation of GDP.

• "C" (Consumption) is normally the largest GDP component in the economy, consisting of private expenditures (household final consumption expenditure) in the economy. Personal expenditure fall under one of following categories : durable goods, non durable goods, and services.
• "I" (Investment) includes for instance, business investment in equipment, but does not include exchanges of existing assets. Spending by households (not government) on new houses is also included in investment. "Investment" in GDP does not mean purchase of financial products. It is important to note that buying financial products is classed as saving, as opposed to investment.
• "G" (Government spending) is the sum of government expenditures on final goods and services. It includes salaries of public servants, purchase of weapons for the military, and any investment expenditure by a government. However, since GDP is a measure of productivity, transfer payments made by the government are not counted because these payment do not reflect a purchase by the government, rather a movement of income. They are captured in "C" when the payments are spent.
• "X" (Exports) represents gross exports. GDP captures the amount a country produces, including goods and services produced for other nations consumption therefore exports are added.
• "M" (Imports) represents gross imports. Imports are subtracted since imported goods will be included in the terms "G", "I" or "C", and must be deducted to avoid counting foreign supply as domestic.

(ii) INCOME APPROACH

The income approach looks at the final income in the country, these include the following categories taken from the U.S. "National Income and Expenditure Accounts" : wages, salaries and supplementary labor income; corporate profits interest; farmer's income and income from non-farm unincorapated. Two non- income adjustments are made to the sum of these categories to arrive at GDP.

• Indirect taxes minus subsidies are added to get from factor cost to market prices.
• Depreciation (or Capital Consumption Allowance) is added to get from net domestic product to gross domestic product.