Transcript Expenditure approach to GDP

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National Income Accounting
Expenditure approach to GDP
Income approach to GDP
Circular flow of income and
expenditure
5. Leakages and injections
6. Limitations of GDP
National income accounting (NIA) is the
measurement of aggregate or total economic
activity.
NIA is useful for assessing
the performance of the
macroeconomy. NIA is also
helpful in evaluating the
effectiveness of policy
initiatives such as the Bush
tax cuts.
“One person’s spending is another person’s income”
Every dime I spend for new
goods and services must be
received as income (wages,
salaries, rent, interest, or profit)
by resource owners.
Aggregate spending for new, final goods
and services = GDP = Aggregate income
received by resource owners (national
Income)
•Expenditure approach to GDP: Add together
all spending on new, final goods and services
produced within the nation’s borders in a year.
•Income approach: Add all earnings from all
resources used to produce output within the
nation’s borders in a year.
GDP = C + I + G + (X – M)
Where,
C is personal consumption expenditure;
I is gross private domestic investment;
G is government expenditure (local, state, and federal)
X is exports, and;
M is imports
The market value of all final goods and
services and services produced during a year
by resources located within the country,
regardless of who owns the resources.
Final goods and services are sold to final, or end, users.
For example, tires purchased by a consumer are final
goods. Tires purchased by Ford Motor are intermediate
goods.
Production in a Toyota Plant in Kentucky is counted in
U.S. GDP. Production in a Ford Plant in Mexico is
counted in Mexican GDP.
Household spending for newlyproduced goods and services is defined
as consumption. We distinguish
between 3 categories or types:
Spending for consumer durables
Spending for consumer nondurables
Spending for consumer services.
Consumer Spending by Type, 2007 (in billions)
Category
Durables
Spending in
2007
Percent
(billions) of Total
$1,082.5
11
Nondurables
2,804.5
29
Services
5,949.7
60
Source: Bureau of Economic Analysis
Total spending by
U.S. households
in 2007 was a
$9.9
trillion
•Business spending for newly built
equipment, software , and
structures.
•Net additions to business
inventories of raw materials ,
semifinished goods, and finished
goods.
•New residential housing
construction.
Investment does NOT include
•The purchase of stocks, bonds, or
other financial assets.
•Secondhand sales
Remember that
investment only
happens when there is
production of new
tangible capital goods
Components of Investment, 2007 (in billions)
$540.20
$505.10
Bus. Structures
Equip. & Software
Residential
$1,024
Inventory investment
(-30.4 billion) not
included
Government Expenditures
All expenditures for newly produced, final
goods and services by all levels of
government.
For purposes of
computing GDP, G
DOES NOT include
transfer payments such
as social security or
food stamps.
We subtract imports
from GDP since we
do not want to count
foreign output in
domestic GDP
Net Exports (NX) of the U.S.
(Monthly)
MEASURING U.S. GDP
The Expenditure Approach
At each stage of production, the selling price of a
product minus the cost of intermediate goods
purchased from other firms.
Value-added is
equivalent to the factor
income earned by
resource owners at a
particular stage of
production (like oil
drilling).
Computation of value added
for a new desk
Stage of
Production
Logger
Miller
Manufacturer
Retailer
(1)
Sale
Value
(2)
Cost of
Intermediate
Goods
(3)
Value
Added
$20
50
120
200
$20
50
120
$20
30
70
80
Market value of final good
$200
The value added at each stage of production is the sale price at that stage minus
the cost of intermediate goods, or column (1) minus column (2).
The value added at each stage sum to the market value of the final good.
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The Income Approach
The NIA divides earned income into 2
categories:
1. Wages or compensation of employees:
Includes wages and salaries plus fringe
benefits—such as health insurance,
pension, and social security contributions.
2. Interest, Rent, and Profit or the net
operating surplus: the sum of the incomes
earned by capital, land, and
entrepreneurship.
Interest, Rent, and Profit
–Interest is the income households receive on
loans they make minus the interest they pay on
their borrowing.
–Rent includes payments for the use of land and
other rented inputs.
–Profit includes the profits of corporations and
small businesses.
Net Domestic Product at Factor Cost:
The sum of factor payments—wages, interest, rent
and profits.
We must make two
adjustments to get from net
domestic product at factor cost
to GDP
1. From factor cost to market price;
2. From gross to net.
From Factor Cost to Market Price
– The expenditure approach values goods at market prices;
the income approach values them at factor cost.
– Indirect taxes (such as sales taxes) make market prices
exceed factor cost.
– Subsidies (payments by government to firms) make factor
cost exceed market prices.
– To convert the value at factor cost to the value at market
prices, we must:
• Add indirect taxes and subtract subsidies
From Gross to Net
–The expenditure approach measures gross
product; the income approach measures net
product.
–Gross profit is a firm’s profit before
subtracting the depreciation of capital.
–Net profit is a firm’s profit after subtracting
the depreciation of capital.
–Depreciation is the decrease in the value of
capital that results from its use and from
obsolescence.
MEASURING U.S. GDP:
The Income Approach
Disposable income (DI) is the income households have
available to spend or save after paying taxes and receiving
transfer payments.
Net taxes (NT) are tax payments minus transfer payments
received
Note that:
GDP = DI + NT
and: DI = C + S
Leakages are any diversion from the domestic
spending stream; includes saving, taxes, and
imports.
Injections are expenditure in domestic
goods markets by spending agents other
than domestic households; includes
investment, government expenditure, and
exports.
National Income accounting identities:
C + I + G + (X – M) = DI + NT
(1)
DI = C + S
(2)
Substitute (2) into (1) to obtain:
C + I + G + (X – M) = C + S + NT
(3)
Canceling out C’s and adding M to both sides:
I+G+X =C+S+M
(4)
Circular flow of income and expenditure
1: GDP=aggregate income
2: Taxes leak
3: Transfer payments enter
Net taxes: NT = taxes – transfers
4: Disposable income flows to
households
DI = aggregate income – NT
5: Households spend or save DI
Consumption enters
Savings leak
6: Investment enter
7: Government purchases enter
8: Imports leak
9: Exports enter
10: Consumption + Investment +
Government purchases + Net export
= Aggregate expenditure
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Expenditure and income statement for the US
economy in 2006 (in trillions of dollars)
Aggregate Expenditure
Consumption (C)
Gross investment (I)
Government purchases (G)
Net exports (X-M)
GDP
$9.22
2.21
2.52
-0.76
$13.19
cc
Aggregate Income
Depreciation
Net taxes on production
Compensation of employees
Proprietors’ income
Corporate profits
Net interest
Rental income of persons
GDP
$1.61
0.92
7.45
1.01
1.55
0.60
0.05
$13.19
32
Deriving net domestic product and national
income in 2006 (in trillions of dollars)
Gross domestic product (GDP)
Minus depreciation
Net domestic product
Plus net earnings of American
resources abroad
National income
$13.19
-1.61
11.58
+ 0.08
$11.66
33
• Deriving personal income and disposable
income in 2006 (in trillions of dollars)
National income
Income received but not earned minus
income earned but not received
Personal income
Minus personal taxes and nontax charges
Disposable income
$11.66
-0.68
10.98
-1.35
$9.63
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Limitations of (real) GDP as a
measure of the standard of
living
•Household (non-market) production
•The underground economy
•Leisure time
•Environment quality
Economist Quality of Life Index
The Economist
Index weighs the
following factors
•Income
•Health
•Freedom
•Unemployment
•Family life
•Climate,
•Political stability and security
•Gender equality
•Family and community life
Index ranges from 1 to
10.
Source: The Economist
Country/Rank1 Index
1
Ireland/1
8.33
Norway/3
8.05
Australia/6
7.93
Italy/8
7.81
Spain/10
7.73
USA/13
7.62
Japan/17
7.39
France/25
7.08
Mexico/32
6.77
China/60
6.08
Indonesia/71
5.81
Russia/105
4.80
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