Principles of MacroeconomicsPrinciples of Macroeconomics

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ECON203,Lecture 4: A Measure of Production and Income

(GDP)Instructor: Turki Abalala

Recap of Last Lecture Recap of Last Lecture

• Measurement approaches of GDP.

• Measuring GDP using Expenditure approach.

Class OutlineClass Outline

Income Approach to measure GDP

Statistical Discrepancy

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)

GDP – Income Approach

The national Income can be divided into two big categories:

1. Wage Income “Compensation employees”: payments for labor services“

2. 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!!).

GDP – Income Approach

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:

1. From factor cost to market price: Add indirect taxes Subtract subsidies

2. 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.

GDP – Income Approach

GDP – Income Approach

Why GDP using Expenditure approach is different from GDP

using Income approach?

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.

GDP: INCOME APPROACHGDP: INCOME APPROACH

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

ReferenceReference

Chapter 5 of “Foundations of Macroeconomics” Pages 121 - 122

Exercises on measuring GDP using both Exercises on measuring GDP using both approaches approaches

Basic QuestionsBasic Questions

1.What does GDP stand for?

2.Define GDP?

3.Why do we need to study GDP?

4.How to measure GDP?

5.What are the components of GDP using the expenditure approach?

ECON203; Section: EA 14

Exercise 1Exercise 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.

15ECON203; Section: EA

Exercise 2Exercise 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 of1. Aggregate income.2. GDP.

16ECON203; Section: EA

Exercise 2 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 of1. GDP.2. Government expenditure

17ECON203; Section: EA

Exercise 3Exercise 3

The table below gives the values of different expenditures in the United States during 1999.

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

InvestmentNet domestic product at factor costConsumption expenditureGovernment expenditure on goods and servicesIndirect taxes less subsidiesExports of goods and servicesImports of goods and servicesDepreciation

1,57688007,9451,630

6697681450700

18ECON203; Section: EA

Exercise 4Exercise 41. The table below shows some items in the US National Income and

Product Accounts in 2005. Calculate GDP in 2005 using expenditure approach.

2. 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 servicesIndirect taxes less subsidiesDepreciationNet factor income from abroadInvestment Net exportStatistical discrepancy

8.72.30.81.50.12.0-0.70

19ECON203; Section: EA

Exercise 5Exercise 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 1200

Government Expenditure 2500 Wages (compensation of employees) 5000 Indirect Taxes 800 Exports 2000 Expenditure on durable goods 1900 Consumption Expenditure 6500

Statistical discrepancy 500

Exercise 6Exercise 6

Use the following data to calculate aggregate expenditure and imports of goods and services. Government expenditure: $20 billionAggregate income: $100 billionConsumption expenditure: $67 billionInvestment: $21 billionExports of goods and services: $30 billion

21ECON203; Section: EA

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Now it’s over for Now it’s over for today. today.

Any question?Any question?