Calculating GDP Expenditure vs. Income Approach AP Macroeconomics Adapted from Ms. McCarthy

EXPENDITURE APPROACH GDP is the sum of all the money spent on buying final goods and services. Which market? PRODUCT MARKET (Circular Flow) INCOME APPROACH GDP is the sum of all the income derived from producing it. Which market? FACTOR MARKET (Circular Flow)

Expenditure Approach Consumption expenditures by household Plus Investment expenditures by businesses Plus Government purchases of goods and services Plus Exports – Imports Formula: GDP = C + I G + G + X N

Expenditure Approach - Consumption Personal consumption expenditures per household Includes: 1.Durable Goods 2.Nondurable Goods 3.Services C

Expenditure Approach - Investment Gross private domestic investment (the words are important) Gross investment includes replacement capital (depreciation) and added capital Gross Investment – Depreciation = Net Investment IgIgIgIg

Includes: 1. All final purchases of machinery, equipment, and tools by business. 2. All construction 3. Increases in inventories (unsold goods) IgIgIgIg Expenditure Approach - Investment

Expenditure Approach - Government Government purchases of goods and services Includes: Federal, state, and local government expenditures Does not include: Transfer payments G

Expenditure Approach - Trade Total Exports (X) – Total Imports (IM) Trade surplus: Export more than you import Trade deficit: Import more than you export X n = X-IM

Income Approach WAGESplusRENTSplusINTERESTplusPROFITSplus INDIRECT BUSINESS TAXES minus NET FACTOR INCOME FROM ABROAD plus CONSUMPTION ON FIXED CAPITAL (DEPRECIATION) plus STATISTICAL DISCREPANCY

Income Approach Resource Market Resource Market It would be simple if we could say that the entire amount of expenditures (C + I + G + X) flowed back in the form of wages, rent, interest, and profit…however we have to make a few adjustments to balance the expenditures and income sides of the account. It would be simple if we could say that the entire amount of expenditures (C + I + G + X) flowed back in the form of wages, rent, interest, and profit…however we have to make a few adjustments to balance the expenditures and income sides of the account.

Wages Compensation for employees Wages Wages Salaries Salaries ◦Salary and supplements, i.e., bonuses Fringe benefits Fringe benefits Payments made on behalf of workers Payments made on behalf of workers ◦e.g., social security benefits, health and pension benefits

Rental income received by the household/businesses that supply property resources Rental income received by the household/businesses that supply property resources Rent

Interest Consists of the money paid by private businesses to the suppliers of money capital (lenders) Consists of the money paid by private businesses to the suppliers of money capital (lenders) In addition, includes interest households receive on savings accounts, CDs, etc. In addition, includes interest households receive on savings accounts, CDs, etc.

Two categories Two categories 1. Proprietor’s income – anything that is not a corporation. 2. Corporate profits – all corporations. Profit

Corporate Profits (TR-TE) Includes: 1. Corporate income taxes – these taxes are levied on corporations’ net earnings and flow to government 2. Dividends – Corporate profits paid to corporate stockholders and thus flow to households 3. Undistributed corporate profits – money saved for future investment

Indirect Taxes Taxes on production Taxes on productionExamples: Excise tax, business property tax, license fees Taxes on imports Taxes on importsExample: customs duties Why do we add these? Why do we add these? ◦Simple answer: accounting convenience

Explanation Assume that a firm produces a product that sells for $1. The production and sale of that product create $1 of wage, rent, interest, and profit income. But now suppose that that government imposes a 5% sales tax on all products sold at retail. The retailer adds the $.05 tax to the price of the product and shifts it along to consumers. But only $1 of the $1.05 consumer expenditures becomes wages, rent, interest, and profit income. So the national income accountants add the $.05 to the $1.00 in order to match up the $1.05 of expenditures on one side of the accounting ledger with the $1.05 of receipts. Accounting rules: both sides have to be equal.

National Income Formula Wages + Rent + Interest + Profit + Indirect Taxes = National Income Wages + Rent + Interest + Profit + Indirect Taxes = National Income So what do we need to do to get from National Income to GDP? Subtract net factor income from abroad Subtract net factor income from abroad Add consumption on fixed capital (depreciation) Add consumption on fixed capital (depreciation) Add statistical discrepancy Add statistical discrepancy = GDP using income approach

Net factor income from abroad Subtract income that foreigners gain by supplying resources to the U.S. Subtract income that foreigners gain by supplying resources to the U.S. Subtract American owned resources abroad Subtract American owned resources abroad

Capital Consumption Allowance AKA “depreciation” allowance AKA “depreciation” allowance Another way to look at it is the allowance for the capital that has been “consumed” in producing the year’s GDP. Another way to look at it is the allowance for the capital that has been “consumed” in producing the year’s GDP. It is the portion of GDP that is set aside to pay for the ultimate replacement of those capital goods. It is the portion of GDP that is set aside to pay for the ultimate replacement of those capital goods. It is an estimate of how much capital is being used each year. It is an estimate of how much capital is being used each year.

Statistical Discrepancy Accountants add a statistical discrepancy to national income to make the income approach match the outcome of the expenditures approach. Accountants add a statistical discrepancy to national income to make the income approach match the outcome of the expenditures approach.

Simplified Equations… ExpenditureIncome GDP = C + I G + G + X N GDP = W + R + I+ P