Income and Spending: The Circular Flow Ways to Measure GDP Circular Flow

Three Ways to Measure GDP (1)The Product Approach. GDP = Total Output of Goods and Services (this is the definition of GDP we discussed earlier) (2)The Income Approach GDP = Total Income of All Domestic Residents (recall Bakery Example)

Some Definitions (i)Total Income = Wages/Salaries + Profits + Interest + Rental (ii)GDP = Total Value Added = Sales Revenue – Costs for Intermediate Goods. (iii)Profits = Sales Revenue – Costs of Intermediate Goods – Other Costs (iv)Other Costs = Wages/Salaries + Interest + Rental

(iii) and (ii) says Profits = Total Value Added – Other Costs = GDP – Other Costs =>GDP= Profits + Other Costs = Profits + Wages/Salaries + Interest + Rental = Total Income

Other Measures of Income: GNP = GDP + Net Income Earned Abroad Net National Product (NNP) = GNP – Depreciation Investment National Income (NI) = NNP – Indirect Business Taxes

(3)The Expenditures Approach GDP = Total Expenditures on Final Goods  Four Major Categories of Expenditures (1) Consumption (C) – Household Spending on Goods and Services (2) Investment (I) – Business Spending on Productive Capital Goods (3) Government Purchases (G) – Government purchases of goods and services (4) Net Exports (NX) = Exports (X) – Imports (M)

Income-Spending Identity: GDP = Total Domestic Income = Total Expenditures GDP = Y = C + I + G + NX

The Circular Flow Four Sectors of the Economy (1)Households (2)Firms (3)Government (4)Foreigners  Capital Markets channel funds from lenders to borrowers. Examples: Banks, Stock/Bond Markets.

Households – Consumers/Workers (everyone) Earns Income or GDP = Y Spends on Consumption = C Pays Taxes (net of transfer payments) = T Disposable Income (DI) = Y – T Saving (S) = DI - C

Business Firms Produces GDP or Y = C + I + G + NX Borrows from capital market to buy investment goods (I).  Government Collects Net Taxes = T Spends on Goods and Services = G Borrows: Federal Budget Deficit = G -T

The Federal Budget Deficit is the excess of government spending over tax revenues or government borrowing in a given year. T – G > 0=> Budget Surplus T – G Budget Deficit The National Debt is the total outstanding debt of the Federal government.

Foreigners – rest of the world Spends on U.S. Exports (X) Sells Imports (M) Net Exports = X – M = NX NX > 0 => Trade Surplus (net foreign lender) NX Trade Deficit (net foreign borrower)

Some Important Relationships: Y = C + I + G + NX S = I + Budget Deficit + NX = I + (G – T) + NX