Measuring GDP using the Income Approach and the Expenditure Approach - HD

Summary

Highlights

• GDP can be measured via the income approach or the expenditure approach. 📊
• The income approach calculates GDP by summing up wages, rents, interests, and profits. 💰
• The expenditure approach sums up consumption, investments, government spending, and net exports. 📈
• The circular flow model illustrates both approaches, showcasing the flow of money, goods, and services. 🔄
• Understanding leakages and injections explains the dynamics of savings, taxes, and international trade. 🌍

Key Takeaways

• GDP can be measured using two distinct approaches: the income approach and the expenditure approach. Each provides a unique lens on a nation's economic activity. 📚
• The income approach sums up the total income earned by households, including wages, interests, rents, and profits. It's all about what households gain! 💵
• The expenditure approach looks at total spending on a nation's goods and services, including consumption, investment, and net exports. It's all about what gets spent! 💳

Overview

Measuring GDP using the Income Approach and the Expenditure Approach - HD Transcription

• 00:00 - 00:30 here we [Music] go hello everybody in today's video lecture we're going to be talking a little bit about macroeconomics specifically the measurement of gross domestic product in this activity we'll be talking about the circular flow of the nation's economy and we'll discuss the two different ways the nation's GDP can be measured using either the income
• 00:30 - 01:00 approach for measuring GDP or the expenditure approach we will apply these two methods for measurement to the circular flow that we see here let's begin by defining gross domestic product more clearly one way to measure GDP is by using the income approach the income approach measures the total income earned by the households in a nation during a year let's look at our graph here and decide where the income in the circular flow is shown any circular flow model includes two markets it includes
• 01:00 - 01:30 households and firms households are the providers of resources to firms who demand resources in order to produce goods and services as we see in our circular flow here households provide land labor and capital to firms in the resource Market in exchange for the provision of these productive resources households receive income in the form of wages interest and rent but before we get into the income approach let's to
• 01:30 - 02:00 find the other way that GDP can be measured another way to measure gross domestic product is by finding the total amount spent on the goods and services produced in the nation by households firms the government and foreigners this is known as the expenditure approach expenditure is another way of saying spending therefore the expenditure approach measures the total amount spent on a nation's goods and services let's look at the circuit of flow model again and find out where the expenditure approach can be seen in this graph let's look in the market now households spend
• 02:00 - 02:30 money in the product market for which they receive goods and services of course households are not the only ones consuming a nation's products firms also consume products in the form of capital goods and governments consume products in the product Market in the form of infrastructure Goods services such as Healthcare education and National Defense let's go into more detail about the income approach now and find out
• 02:30 - 03:00 how we can find the total income in a nation therefore the total GDP by breaking down the different types of income earned by households by providing their productive resources to firms in the resource Market households can earn several different types of income as we know the different resources that households provide to firms are land labor capital and their entrepreneurship for each of these types of productive resources households receive money in incomes in
• 03:00 - 03:30 return for land households receive rental income therefore the payment that households receive for land is called rent an example of this is a farmer who owns his own land yet he rents it out to a corporation that Farms wheat on his land the corporation is paying the land owner rental income for the permission to use his land to grow wheat on next let's talk about labor labor seems fairly obvious a worker is somebody who goes to work every day provides a labor
• 03:30 - 04:00 of some sort whether it's manual labor or intellectual labor either way households provide workers for firms in exchange for their labor households earn what we call wages wages are the payment households receive in exchange for their labor wages could be high wages if a person is providing a particularly valuable type of Labor such as Medical Services or they could be low wages if an individual is providing lower skilled labor such as construction work or menial service
• 04:00 - 04:30 either way the wages a household earns are considered the income they earn in exchange for their labor resource next let's talk about capital capital is a little bit more difficult to understand first we'll we'll identify the income received in exchange for their Capital households receive interest payments in exchange for their capital resources to explain this we need to look at one of the uh components of our um circular flow diagram here and that is the banking sector so let's look over here at the banking sector and we can
• 04:30 - 05:00 determine how households receive payments in exchange for their Capital as you know many households like to save money of course savings is considered a virtue when households save money there is a leakage from the circular flow of income this is because a penny saved is not a penny spent therefore there is less spending on goods and services when households save however money saved is not wasted money saved in Banks is invested by those Banks who loan that money back to business firms which need
• 05:00 - 05:30 to borrow money to acquire Capital Equipment to pay their workers and to cover other costs of production when a business firm borrows money from a bank to operate its business it pays the bank interest in return for the privilege of borrowing that money of course whose money are the firms borrowing ultimately the money being borrowed belongs to households who have savings at that bank and that way households that save money at Banks receive interest payments in
• 05:30 - 06:00 return for the bank lending that money to business firms so savings is considered a leakage from the circular flow but it is savings that enables firms to invest in Capital Equipment therefore investment is considered an injection into the circular flow as we see on the graph here that's why the Green Arrow from investment points into the circular flow model sorry the yellow arrow but the green highlighted Arrow here is a leakage in in the form of
• 06:00 - 06:30 savings households receive interest payments for money that they save at Banks Banks earn that interest by lending that money to firms and that way firms are able to acquire Capital using money lent to them through the banking system that ultimately belongs to households that leaves us with entrepreneurship households some households are entrepreneurs these are the business owners these are the business owners who seek profits by opening a business of their own starting a business
• 06:30 - 07:00 Enterprise if a household starts his or her own business they are ultimately seeking profits therefore the income earned by households Who start their own business is known as profit if we take the total rents wages interest payments and profits earned by households we get the total income of the nation which when summed together will give us the GDP or the gross domestic product of the
• 07:00 - 07:30 in this way the income approach measures the total rent wages interest and profits earned by households to find the total income earned in the resource Market in the nation in a year next let's talk about the expenditure approach of measuring GDP as I explained before expenditures is another word for spending in this way the expenditure approach of measuring GDP sums the total amount spent on goods and services produced in the nation spending occurs by households by firms by the government and by foreigners
• 07:30 - 08:00 let's talk about each of these one at a time when households spend money on goods and services this is considered consumption or Capital C in our simplified equation consumption includes all spending by households on goods and services but with this money income as we see in our graph here the money returns to firms in the form of consumption in the product Market the next type of expenditure that occurs in a country is spending by firms on capital goods this
• 08:00 - 08:30 we call investment now when we use the word investment here we're talking about a very particular type of investment for example if I said that I'm investing in my education by paying for private school tuition this is technically not investment from an economic standpoint because what I'm really doing is paying tuition and buying the service of Education in the product Market hence spending money on private school education is actually a form of consumption investment from a macroeconomic standpoint includes all
• 08:30 - 09:00 spending by firms on capital goods so we can just call investment Capital spending by firms of course capital goods means the tools the technology used in the production of goods and services whenever a firm buys a new piece of technology or Capital this is considered investment the next stakeholders who spend money in the nation's economy are the government we simply call this government spending what type types of things do governments spend money on
• 09:00 - 09:30 this may include education such as public schools infrastructure such as roads and bridges government spending may also include spending on health care for the elderly or for the unemployed or for the poor households in the nation anytime a government provides public goods to the nation's firms or households this is considered government spending and it is therefore an injection into the nation's circular flow but this raises the question where does government get the money to spend
• 09:30 - 10:00 on goods and services for the nation's households and firms of course as anybody who has ever filed taxes and earned an income knows tax money spent by households and firms go to the government sector to allow them to provide the goods and services that firms and households benefit from therefore taxes are considered a leakage from the circular flow whereas government spending is considered an injection into the circular flow this leaves one final stakeholder when considering the different types of spending that can go on in a nation and
• 10:00 - 10:30 that is foreigners foreigners buy a nation's exports let's look again at our model here we have the foreign sector in the upper leftand corner in the foreign sector money spent by foreigners on our nation's exports are considered an injection into the circular flow this is because foreigners who earn their own incomes in their own resource Market are choosing to spend some of those hard- eared incomes on our nation's Goods this leads to an increase in our
• 10:30 - 11:00 nation's GDP since there's money flowing into the economy but that raises the question what if somebody in our nation buys a good from abroad in other words buys an import of course naturally any money spent on Imports within our nation has to be subtracted from the GDP this is because import spending is considered a leakage from the circular flow that's why the arrow points out of the circular flow model if I buy a t-shirt made in
• 11:00 - 11:30 China then the money I spent on that t-shirt goes to a Chinese household not to an American household or in my case of Swiss household since I live in Switzerland so here we have the four different types of expenditures that occur in a country these can be summarized as C plus I plus G Plus X which stands for exports minus M which stands for imports if we add these together we get the nation's G DP this
• 11:30 - 12:00 is known as the expenditure approach and the GDP found by finding C plus I + G Plus x - M gives us the total expenditures in a nation in a year now why does the total income of a Nation equal the total expenditures because that's really what we're saying here we're saying that the GDP regardless of how it is found will equal the sum of either wages rent interest and profits or consumption investment
• 12:00 - 12:30 government spending and exports minus Imports here we can see that any money earned by households in the resource Market ultimately is spent by households in the product Market therefore income earned is money spent income equals expenditures now households are not the only ones spending money in a country so what about money spent by domestic households on foreign Goods if households Buy imports from another
• 12:30 - 13:00 country why does this money always come back to the country uh from which those households are spending well the answer there is that money spent by let's say an American household on a t-shirt made in China of course I'm spending US Dollars on that t-shirt so money earned by the Chinese firms or sorry the Chinese firms and households who produced that t-shirt the only where way those US Dollars can be spent is if it comes back to the United States in the form of exports for the United States in this way a leakage in the form of import spending turns into an injection in the
• 13:00 - 13:30 form of export sales the same goes for investment if households save money in Banks ultimately that money will be reinjected into the economy through investment so thus the banking sector also has leakages and injections the same goes for government spending if go if households and firms pay taxes to the government most of the time this tax money will be spent again on public goods for households and firms by the government so any income earned some of which is spent on domestic Goods some of
• 13:30 - 14:00 which is used to buy imports some of which is used to pay taxes with and some of which is saved ultimately turns into expenditures or spending in the form of government spending investment by firms and the purchase of exports by foreigners in this way the total income earned in a nation is equal to the total expenditures from all stakeholders on that nation's goods and services and thus we have a complete circular flow and two different ways to measure GDP