16B: measuring GDP and economic growth

Measuring GDP:- income approach 

GDP is the sum of the total amount received/income earned by the owners of the factors of production (the households), who help in producing goods and services.  The income earned includes wages and salaries, renal incomes etc. therefore GDP = Y


  • Households use this income to buy goods and services - this is to incur consumption expenditure (C) , pay taxes (T) and for saving (S). this can be expressed as follows:-

    • Y=C+S+NT 

    • C+S=YD (disposable income) 

    • NT= net tax = tax-transfer payment 

    • So, Y=YD+NT 

  • The income approach measures GDP by summing the incomes that firms pay household foe the factors of production they hire 

  • Income is divided into 3 categories 

    • Wage income (wage + fringe benefits) 

    • Company profits and imputed rent 

    • Mixed income 


Measuring GDP:- expenditure and income approach 

first adjustment

  • The expenditure method values goods @ market price (includes indirect tax)  

  • The income approach values goods @ factor cost (does not include indirect tax) 

    • Therefore, economist add ‘net indirect taxes’ to income approach 

    • Net indirect taxes = indirect taxes - subsidies 


Expenditure equals income 

Exam question: Using the circular flow model, with the aid of a diagram show that aggregate expenditure equals aggregate income. 


1st paragraph: diagram + write introduction + definitions 


  • As the circular flow model of income and expenditure shows, aggregate expenditure is the money spent on buying goods and services by all the sectors in the economy.  


  • And this money spent on buying goods and services by all the sectors in the economy, this aggregate expenditure is the revenue of the firm. The firm uses this revenue to make payments to the owners of the factors of production. These payments are called aggregate income. 


2nd paragraph: 


  • As a result, aggregate expenditure (which equals revenue of the firm) equals aggregate income. After making payments to the owners of factors of production, if something is left behind, it is the profit of the firm. (Keep in mind that profit is nothing but the reward for entrepreneurship and hence a part of a household's income- after all enterprising households end up as firms!) 

  • Hence, GDP=AE=Y



3rd paragraph: explain calculations 


GDP=AE= C+I+G+EX-IM 

GDP=Y=C+S+T 


C+I+G+NX=C+S+T

I+G+EX=S+T+IM 

Injections = leakages 


Measuring GDP:- Nominal and real 

Nominal

  • Not adjusted for inflation 

  • Bad 


Real 

  • Adjusted for inflation 

  • Good 

  • More accurate 


Business cycle 

The business cycle is the periodic but irregular up-and-down movement in economic growth (production) and other measures of economic activity. Every business cycle has two phases and two turning points.


Two phases: 

  1. An expansion 

  2. A contraction 


Two turning points 

  1. A peak 

  2. A trough 



Aggregate expenditure and aggregate demand 

Aggregate demand = is the demand for and hence money spent on all goods and services by all the sectors in the economy 


Q. So, what is the difference between Aggregate expenditure and Aggregate Demand ? Are they the same? 


Ans:

Aggregate Demand is the same as Planned Aggregate Expenditure. and not Actual Aggregate Expenditure. 


In equilibrium:- 

✓ Actual aggregate expenditure equals Planned aggregate expenditure. There is no distinction between the two. 

✓ And as Planned aggregate expenditure = AD, most textbooks use AD and AE interchangeably


Actual and planned aggregate expenditure 

  • Actual aggregate expenditure is the money actually spent by the different sectors in the economy. The components of actual aggregate expenditure (AE) are: (actual) consumption expenditure (C); (actual) investment expenditure (I); (actual) government expenditure (G) and (actual) value of net exports (NX). 


  • Y= (A) AE=C+I+G+NX


  • Planned aggregate expenditure is the money the different sectors plan to spend. Planned aggregate expenditure ‘(P) AE’ is equal to the sum of (planned) consumption expenditure ‘(P) C’, (planned) investment expenditure ‘(P) I’, (planned) government expenditure (G) ‘(P) G’ and (planned) value of net exports ‘(P)NX’ (P) 


  • AE= (P) C+ (P) I+ (P) G+(P)NX 


Aggregate demand 

The ÅD curve shows the relationship between the price level and real GDP demanded when all other factors which influence expenditure plans remain the same. 


Factors like:-

✓ Interest rates 

✓ Exchange rates 

✓ Disposable income 

✓ Consumer confidence 

✓ Business confidence 

✓ Taxes and government expenditure etc.



Aggregate supply

AS/ SRAS curve shows the relationship between the aggregate price level and real GDP supplied when all other factors which influence production plans remain the same.


 Factors like:- 

✓ Interest rate 

✓ Exchange rates 

✓ Availability (quality and quantity) of factors of production 

✓ Money wage rate ( and money prices of other resources)