Gross Domestic Product: Focus on the: Expenditure Approach

Professor Jermaine Whirl, MBA, ED.M Information to use by students of East Georgia College

Why even study or measure the economy?

Remember from our discussions on economic history that truly before 1776 there was no need for economists. Economic systems were in all other forms except for market economies. Well in order for us to understand the fundamentals of the French Physiocrats we must understand that they were upset with the current economic conditions of France at the time. Secondly, they argued to change the government's mercantilistic ways and actually measure economic output. According to them, true economic freedoms and expansion can only occur if we know how we are truly doing. Adam Smith took their writing along with David Hume to develop the Wealth of Nations book that focuses on increasing the wealth of the total nation and not just several members. Today we focus on measuring the economy as a true means of knowing where we stand in production, and to measure our growth over time.

Circular Flow of Income

Households pay taxes, provide savings to banks, provide labor, and purchase goods and services. Government purchases goods and services, collect taxes, & enter into contracts Businesses purchase labor (provides wages), provides goods and services, enter into contracts with the government, and invest money with financial institutions. Financial Firms- Provided investment opportunities for firms & government, & provide savings opportunity for households.

GDP
GDP is the total market value of final goods and services produced within the borders of a nation during a fixed period of time. Ready and Used for final consumption.
We only use final goods, because we don't want to double count any intermediate goods that were used in the production of final goods.

GNP
Gross National Product is the value of final goods and services produced by residents of the United States, even if the production takes place outside the United States. Examples: Ford assembling vehicles in the UK or Egypt. GNP includes foreign production by U.S. firms, but excludes U.S. production by foreign firms.

Who Calculates it?

GDP & GNP Calculations are calculated by the Bureau of Economic Analysis; located within the Dept of Commerce. The BEA reports GDP on a quarterly basis. (4 times a year)

3 Ways of Measuring the Economy (GDP)

Income Approach:
The approach to calculating GDP that involves measuring the income generated to all of the participants in the economy.

Product Approach:
A procedure for measuring economic activity by adding the market values of goods and services produced, excluding any goods and services used up in intermediate stages of production; equivalently by summing the value added of all producers.

*Just know what they are*- All of the methods are equivalent-

The Expenditure Approach

Must Remember this Equation:

Y=C+I+G+NX
Y= Real GDP
I=Investment G=Government Expenditures NX= Net Exports (Exports-Imports) C= Consumption (US)

Consumption
Consumption is spending by domestic households (us) on final goods and services; including those produced abroad.
This is the largest component of expenditure
Usually accounts for 2/3 of GDP in the US. Consumption Expenditures are grouped into 3 categories:
Consumer Durables- Example: cars, TVs, Furniture Nondurables: food, clothing, fuel Services: education, financial, & healthcare

Calculating Consumption/ Consumer Durables

Durable Goods Calculation: When calculating durable goods we must account that we will obtain utility from them for more than a years time. Two Examples
Home Purchase; We would use the rent/mortgage rate

Two Examples
Home Purchase; We would use the rent/mortgage rate Vehicles; We would use the leasing rate of the vehicle.

Calculating Consumption/ Services

We all account for any new services one may consume during a quarterly time period. Examples:
Legal Services Education Services Rent on housing Mortgage Rates on housing Haircuts Commission Sales Hospital services

Investment
Investment: includes both spending for new capital goods, called fixed investments, and increase in firms' inventory holdings, called inventory investment. Depreciation: Machinery tears down within a years time. We adjust for this by subtracting out the depreciation expenses and obtaining capital consumption allowance. Fixed investment- is spending by businesses on structures (factories, warehouses, & office buildings) and equipment such as machines, vehicles, & computers) Residential investment- is spending on construction of new houses and apartment buildings.

Investment Calculation
Residential Inventory is only counted as the work occurs, not when the structure (home) is completed or sold. Manufactured homes are counted as a residential investment only when the home is completed and shipped. Fixed Investment is only counted as the work occurs, not when the structure (home) is completed or sold.

Government Purchases
Government Purchases: Services and goods purchased by the government foreign or domestic. Can be purchases made by the federal, state, or local government. Third Major component of spending. Govt Tax Collection- Govt Spending Budget deficit, surplus, or balance budget *Not all checks from the government are for purchases of current goods and services.* Transfer Payments: for things such as social security, and Medicare benefits, unemployment insurance, welfare payments are payments primarily to individuals by the government that are not made in exchange for goods or services. Interest Payments too are not counted as part of Government purchases.

Government Spending
Annual Nominal Government Expenditures in 2007

Federal: National Defense Federal: Non-Defense State and Local

Consumption/Investment $578.9 Consumption/Investment $277.2 Consumption/Investment $1,365.9

Notes: Notice that State and Local Government Spending doubles Federal Government Spending!

Note 2: Note that the Federal Government Collects a lot more money in taxes than do state and local government. But the majority of it goes out as transfer payments to the population and not for general consumption of goods or services.

Note 3: Much state and local spending is dedicated to educational spending! Investment spending in human capital

Net Exports
Net Exports:
Are simply exports minus imports. Exports are goods and services produced within a county and purchased by foreigners (we're selling our goods and services) Imports are the goods and services produced abroad that are purchased by a country's residents.
Exports are added to total spending because they represent spending (by foreigners) on final goods and services produced within the home country. Subtracting Imports ensures that total spending, C +I+G+NX, only reflects output produced in the country.

Things that are not counted in GDP

Underground economy: It is estimated that there are $ 1 trillion worth of products and services sold and purchased on black markets. These can be legal or illegal purchases, but they are not calculated or reported as income. Examples waitress may not report all of their tip income, or vendors at flea markets may not report all of their under-the-table cash transactions. Illegal purchases of music or electronics products are not recorded too. Household production: Whether it be stay at home mothers or individuals who change their own oil or fix their own hair would not be counted in GDPs consumption logs.

Value of Leisure:
Leisure time is an economic good, but there is no quantitative way to measure the economic impact of leisure.

Financial Transactions & Income Transfers

Calculating GDP
First be able to calculate what is & is not counted. Remember GDP only counts new goods and services produced within the current quarter. Here is an example: Be able to tell what is counted and where: Consumption: Durable, Nondurable, Service Investment: Residential, Business inventory, Fixed
$60 Bicycle Repair $400 Purchase of Food $90,000 Construction Costs of a New Home $1,900 Rental Income $50,000 Newly Purchased Missles $30,030 Imports $69,000 Exports $34,900 Food Stamps Payments $ 12,444 Depreciation Expense $40,000 New Business Inventory Change $90,000 Tax Collection $433 Used TV Purchase