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Principles of Macroeconomics

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1 Principles of Macroeconomics
ECON203, Lecture 4: A Measure of Production and Income (GDP) Instructor: Turki Abalala

2 Recap of Last Lecture Measurement approaches of GDP.
Measuring GDP using Expenditure approach.

3 Class Outline Income Approach to measure GDP Statistical Discrepancy

4 GDP – Income Approach GDP: the aggregates of all the incomes earned by resource suppliers in the economy. The Income approach measures GDP by summing the incomes that firms pay households for the factors of production they hire (wages for labor, interest for capital, rent for land, and profit for entrepreneurship) To measure GDP using income approach, the Bureau of Economic Analysis uses income data collected by the Internal Revenue Service and others. BEA takes the incomes that firms pay households for the services of the factors of production they hire- wages for labor, interest for the use of capital, rent for the land, and profit for entrepreneurship~ and sum those incomes.

5 GDP – Income Approach The national Income can be divided into two big categories: Wage Income “Compensation employees”: payments for labor services“ Interest, Rent and Profit Income “Net operating surplus”: other factors of production incomes: Net interest. Rental income. (including imputed rent) Profit income: Corporate profit and Proprietors’ income. The sum of wage, interest, rent, and profit equals Net Domestic Product at Factor Cost (not GDP yet!!).

6 GDP – Income Approach

7 GDP – Income Approach Net Domestic Product at Factor Cost is the sum of wages, interest, rent, and profits. Net Domestic Product is Not GDP To arrive to GDP, it needs two further adjustments: From factor cost to market price: Add indirect taxes Subtract subsidies From net product to gross product: Add depreciation to total income Depreciation is the decrease in the value of capital that results from its use and from obsolescence.

8 GDP – Income Approach

9 GDP – Income Approach Why GDP using Expenditure approach is different from GDP using Income approach?

10 GDP – Income Approach In fact, the income approach and the expenditure approach do not deliver exactly the same estimate of GDP because there is a statistical discrepancy. Statistical discrepancy: the discrepancy between the expenditure approach and income approach estimates of GDP, calculated as the GDP expenditure total minus the GDP income total.


12 GDP – Income Approach Productions that are not included in GDP:
With some minor exceptions, GDP includes only those products that are sold in markets Ignores “do-it-yourself” household production  an economy in which householders are largely self-sufficient will understate GDP Ignores the underground economy: all market activity that goes unreported because it’s illegal or those involved want to evade taxes

13 Reference Chapter 5 of “Foundations of Macroeconomics” Pages

14 Exercises on measuring GDP using both approaches
Basic Questions What does GDP stand for? Define GDP? Why do we need to study GDP? How to measure GDP? What are the components of GDP using the expenditure approach? ECON203; Section: EA

15 Exercise 1 Classify each of the following items as a final good or service or an intermediate good or service and identify which is a component of consumption expenditure, investment, or government expenditure on goods and services: Banking services bought by a student. New cars bought by Hertz, the car rental firm. Newsprint bought by USA Today . The purchase of a new limo for the president. New house bought by Al Gore. ECON203; Section: EA

16 Exercise 2 Use the figure below, which illustrates the circular flow model, to work Problems 1 and 2. Problem 1: During 2008, in an economy: ■ Flow B was $9 trillion. ■ Flow C was $2 trillion. ■ Flow D was $3 trillion. ■ Flow E was –$0.7 trillion. Name the flows and calculate the value of 1. Aggregate income. 2. GDP. Aggregate Income = = 13.3 GDP= aggregate expenditure = aggregate income = 13.3 ECON203; Section: EA

17 Exercise 2 Problem 2: During 2009, Flow A was $13.0 trillion,
Flow B was $9.1 trillion, Flow D was $3.3 trillion, Flow E was –$0.8 trillion. Calculate the 2009 values of 1. GDP. 2. Government expenditure 1- GDP = Flow A = 13 trillion 2- Government Expenditure = G = Flow C F.A = F.B + F.D + F.C + F.E 13 = FC – 0.8 FC = 1.4 ECON203; Section: EA

18 Exercise 3 The table below gives the values of different expenditures in the United States during Q1. What was the value of net exports in 1999? Q2. What was GDP using income approach in 2009? Q3. What was the statistical discrepancy in 2009? and the value of total production? Item Billions of dollars Investment Net domestic product at factor cost Consumption expenditure Government expenditure on goods and services Indirect taxes less subsidies Exports of goods and services Imports of goods and services Depreciation 1,576 8800 7,945 1,630 669 768 1450 700 Q1. NX = Export – Import = 768 – 1450 = -682 Q2. Net Domestic Product at Factor cost + Indirect taxes less subsidies + Depreciation = = 10169 Q3. Statistical Discrepancy = Total Expenditure – Total Income = – = 300 Value of total production = 10469 ECON203; Section: EA

19 Exercise 4 The table below shows some items in the US National Income and Product Accounts in Calculate GDP in 2005 using expenditure approach. The Commerce department reported that sales of nondurable goods fell 0.6%, while sales of durable goods decreased 1.5% in August. Inventories of durable goods increased 1.4%. Which component of GDP will be affected for each change? Item Billions of dollars Consumption expenditure Government expenditure on goods and services Indirect taxes less subsidies Depreciation Net factor income from abroad Investment Net export Statistical discrepancy 8.7 2.3 0.8 1.5 0.1 2.0 -0.7 Nondurable goods fell 0.6% = consumption expenditure fell by 0.6% Durable goods decreased 1.5% = consumption expenditure fell by 1.5% Inventories of durable goods increased 1.4%. = investment increased by 1.4% ECON203; Section: EA

20 Exercise 5 The following table shows some of the items in Saudi Arabia’s National Income and Product Accounts in 2012. Calculate Saudi Arabia’s GDP using Income approach? Item Value in Billions of Riyals Expenditure on used goods 370 Subsidies (benefits from the government to firms) 300 Gross Investment 1200 Imports Government Expenditure 2500 Wages (compensation of employees) 5000 Indirect Taxes 800 Exports 2000 Expenditure on durable goods 1900 Consumption Expenditure 6500 Statistical discrepancy 500 GDP = GDP using expenditure approach – statistical discrepancy = [ (2000 – 1200) ] – 500 = – 500 = 10500

21 Exercise 6 Use the following data to calculate aggregate expenditure and imports of goods and services. Government expenditure: $20 billion Aggregate income: $100 billion Consumption expenditure: $67 billion Investment: $21 billion Exports of goods and services: $30 billion * Aggregate Expenditure = Aggregate Income = 100 billion 100 = ( 30 – M ) M = – 100 M = 38 ECON203; Section: EA

22 Now it’s over for today. Any question?
HBC608 ECON582 HBC608HBC608 Now it’s over for today. Any question? Finance NotesFinance notes Finance notes 22

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