Principles of Macroeconomics ECON203, Lecture 4: A Measure of Production and Income (GDP) Instructor: Turki Abalala 1 Recap of Last Lecture • Measurement approaches of GDP. • Measuring GDP using Expenditure approach. Class 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 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 Reference Chapter 5 of “Foundations of Macroeconomics” Pages 121 - 122 Exercises on measuring GDP using both approaches Basic 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 approach? GDP using the expenditure ECON203; Section: EA 14 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 15 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. ECON203; Section: EA 16 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 ECON203; Section: EA 17 Exercise 3 The table below gives the values of different expenditures in the United States during 1999. 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. 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? ECON203; Section: EA 18 Exercise 4 1. The table below shows some items in the US National Income and Product Accounts in 2005. Calculate GDP in 2005 using expenditure approach. 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 0 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? ECON203; Section: EA 19 Exercise 5 The following table shows some of the items in Saudi Arabia’s National Income and Product Accounts in 2012. Item Expenditure on used goods Subsidies (benefits from the government to firms) Gross Investment Imports Government Expenditure Wages (compensation of employees) Indirect Taxes Exports Expenditure on durable goods Consumption Expenditure Statistical discrepancy Value in Billions of Riyals 370 300 1200 1200 2500 5000 800 2000 1900 6500 500 Calculate Saudi Arabia’s GDP using Income approach? 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 ECON203; Section: EA 21 Now it’s over for today. Any question? 22