Chapter 20
GDP or gross domestic product: the market value of all final goods and services produced
within a country in a given time period.
GDP has 4 parts:
1. Market value
the prices at which the items are traded in markets
2. Final goods and services
a final good is an item or service that is bought by its end user during a specified time
period. Intermediate good is an item that is produced by one firm, bought by another
firm and used as a component of a final good or service.
3. Produced within a country
only goods and services that are produced within a country count as part of that country’s
GDP
4. In a given time period
GDP measures the value of production in a given time period, normally a quarter of a
year or a year.
The economy exists of households, firms, governments and rest of the world.
Households and firms
Households sell and firms buy the services of labor, capital and land in factor markets. For these
factor services, firms pay income to households: wages for labor services, interest for the use of
capital and rent for the use of land.
Households buy and firms sell consumption, goods and services. Total payment of these goods is
called consumption expenditure.
The purchase of new plant, equipment and buildings, and the additions to stocks are investment.
Government
Governments buy goods and services from firms, and their expenditure on goods and services is
called government expenditure.
Rest of world
,Firms in countries sell goods and services to the rest of the world, exports, and buy goods and
services from the rest of the world, imports.
The value of exports minus the value of impots is called net exports.
If net exports are positive, the net flow of goods and services is from the country’s firms to the
rest of the world. If net exports are negative, the net flow of goods and services is from the rest
of the world to the country’s firms.
The circular flow of expenditure and income
GDP can be measured in 2 ways: by the total expenditure on goods and services (expenditure
approach) or by the total income earned by producing goods and services (income approach).
Aggregate expenditure: the sum of consumption expenditure, investment, government
expenditure and net exports. A sum of the red flows in the figure above.
Aggregate income: the sum of wages, interest, rent and profit. A sum of the blue flows in the
figure above.
Aggregate income equals aggregate expenditure:
, Y= C+I+G+X-M
GDP equals aggregate expenditure and equals aggregate income
The circular flow model is the foundation on which the national economic accounts are built.
Governments collect income taxes and pay benefits such as pensions to households. These items
are neither expenditures on goods and services nor incomes of factors of production, so they are
not part of the circular flow of expenditure and income. But,
- Indirect taxes are included in market prices
- Subsidies payments to firms lower market prices
So aggregate expenditure valued at market prices includes indirect taxes minus subsidies.
Aggregate expenditure equals aggregate income plus taxes minus subsidies.
Gross in GDP means before deducting the depreciation of capital.
Depreciation: the decrease in the value of a firm’s capital that results from wear and tear and
obsolescence.
Gross investment: the total amount spent on purchases of new capital and on replacing
depreciated capital.
Net investment: the amount by which the value of the firm’s capital increases
Net investment= gross investment – depreciation
The expenditure approach
The expenditure approach measures GDP as the sum of consumption expenditure (C),
investment (I), government expenditure on goods and services (G) and net exports of goods and
services (X-M), corresponding to the red flows in the figure below.
GDP or gross domestic product: the market value of all final goods and services produced
within a country in a given time period.
GDP has 4 parts:
1. Market value
the prices at which the items are traded in markets
2. Final goods and services
a final good is an item or service that is bought by its end user during a specified time
period. Intermediate good is an item that is produced by one firm, bought by another
firm and used as a component of a final good or service.
3. Produced within a country
only goods and services that are produced within a country count as part of that country’s
GDP
4. In a given time period
GDP measures the value of production in a given time period, normally a quarter of a
year or a year.
The economy exists of households, firms, governments and rest of the world.
Households and firms
Households sell and firms buy the services of labor, capital and land in factor markets. For these
factor services, firms pay income to households: wages for labor services, interest for the use of
capital and rent for the use of land.
Households buy and firms sell consumption, goods and services. Total payment of these goods is
called consumption expenditure.
The purchase of new plant, equipment and buildings, and the additions to stocks are investment.
Government
Governments buy goods and services from firms, and their expenditure on goods and services is
called government expenditure.
Rest of world
,Firms in countries sell goods and services to the rest of the world, exports, and buy goods and
services from the rest of the world, imports.
The value of exports minus the value of impots is called net exports.
If net exports are positive, the net flow of goods and services is from the country’s firms to the
rest of the world. If net exports are negative, the net flow of goods and services is from the rest
of the world to the country’s firms.
The circular flow of expenditure and income
GDP can be measured in 2 ways: by the total expenditure on goods and services (expenditure
approach) or by the total income earned by producing goods and services (income approach).
Aggregate expenditure: the sum of consumption expenditure, investment, government
expenditure and net exports. A sum of the red flows in the figure above.
Aggregate income: the sum of wages, interest, rent and profit. A sum of the blue flows in the
figure above.
Aggregate income equals aggregate expenditure:
, Y= C+I+G+X-M
GDP equals aggregate expenditure and equals aggregate income
The circular flow model is the foundation on which the national economic accounts are built.
Governments collect income taxes and pay benefits such as pensions to households. These items
are neither expenditures on goods and services nor incomes of factors of production, so they are
not part of the circular flow of expenditure and income. But,
- Indirect taxes are included in market prices
- Subsidies payments to firms lower market prices
So aggregate expenditure valued at market prices includes indirect taxes minus subsidies.
Aggregate expenditure equals aggregate income plus taxes minus subsidies.
Gross in GDP means before deducting the depreciation of capital.
Depreciation: the decrease in the value of a firm’s capital that results from wear and tear and
obsolescence.
Gross investment: the total amount spent on purchases of new capital and on replacing
depreciated capital.
Net investment: the amount by which the value of the firm’s capital increases
Net investment= gross investment – depreciation
The expenditure approach
The expenditure approach measures GDP as the sum of consumption expenditure (C),
investment (I), government expenditure on goods and services (G) and net exports of goods and
services (X-M), corresponding to the red flows in the figure below.
