Question

GDP may be found by (LO2, 3) a) adding together money spent on goods and services and incomes received by the factors of production b) subtracting incomes received by the factors of production from the money spent on goods and services c) subtracting the money spent on goods and services from the incomes received by the factors of production d) adding the money spent on final goods and services

Short answer

The correct answer is d) adding the money spent on final goods and services. This statement is the correct way to calculate GDP using the expenditure approach, as it refers to the total amount spent on all final goods and services produced in a country during a specific period.

Step-by-step solution

Understand GDP

GDP represents the total value of all goods and services produced in a country over a specific period (usually a year). There are three main ways to calculate GDP: the production approach, the income approach, and the expenditure approach. In this exercise, we will focus on the expenditure approach.

Expenditure approach

The expenditure approach involves calculating the total amount spent on all final goods and services produced in a country during a specific period. In other words, it measures how much people, businesses, and the government spend on goods and services.

Check each statement

Now, let's examine each statement given in the exercise: a) adding together money spent on goods and services and incomes received by the factors of production. This statement combines parts of the expenditure approach (money spent on goods and services) and the income approach (incomes received by factors of production). It is not accurate. b) subtracting incomes received by the factors of production from the money spent on goods and services. This statement, in contrast to the first one, is a mix of the expenditure and income approaches, but with subtraction rather than addition. This is not the correct way to calculate GDP using the expenditure approach. c) subtracting the money spent on goods and services from the incomes received by the factors of production. This statement is similar to statement b) but with the elements reversed. It is still not the correct way to calculate GDP using the expenditure approach. d) adding the money spent on final goods and services. This statement is the correct way to calculate GDP using the expenditure approach, as it refers to the total amount spent on all final goods and services produced in a country during a specific period. Based on our analysis, the correct answer is: d) adding the money spent on final goods and services.

Key concepts

Expenditure Approach

Understanding the calculation of a country's Gross Domestic Product (GDP) is crucial for analyzing its economic health. The expenditure approach, one of the methods to determine GDP, is essentially the 'spending' lens through which economists view the economy. This approach calculates GDP by adding up all the expenditures made on final goods and services over a specific time period, usually a year.

Final goods and services refer to those that are bought by their final user; they will not be sold again or used to make another product. These expenditures include consumer spending, investments, government spending, and net exports (exports minus imports). To depict this mathematically, the GDP can be represented by the formula:
GDP = C + I + G + (X - M)
where C represents consumption or consumer spending, I denotes investments, G stands for government spending, and (X - M) are the net exports.
The expenditure approach helps to show the demand-side performance of the economy, emphasizing the importance of spending and highlighting the contribution of different sectors (consumers, investment, government, and foreign markets) to the overall economic activity.

Income Approach

Contrasting the expenditure approach, the income approach to calculating GDP gives us insight from the income perspective. This approach totals the income earned by all factors of production in an economy, including wages paid to labor, the income earned by capital in the form of rent (for land), interest (for capital), and profits (for entrepreneurship).

Summing these various incomes paints a picture of the economy's health by reflecting the total earnings from domestic and foreign entities. This method can be represented by the following formula:
GDP = W + R + I + P + (Taxes - Subsidies on Production & Imports) + (Net Foreign Factor Income)
where W stands for wages and salaries, R is rent, I represents interest, P stands for profit, and the rest adjust for taxes, subsidies, and foreign factor income.
It's important to note that while this method focuses on income, it should theoretically match the total found by the expenditure approach, as one person's expenditure becomes another person's income. However, discrepancies can arise due to statistical discrepancies, measurement errors, or the underground economy.

Production Approach

The production approach, sometimes called the output approach or the value added approach, is another angle from which GDP can be measured. This method calculates the total value of output produced by an economy but it goes beyond merely adding up the final retail prices of goods and services. It accounts for the value added at each stage of production.

To clarify, consider a simplified scenario of bread production: value is added when a farmer grows wheat, more value is added by a miller who turns wheat into flour, and further value is added by a baker who uses flour to make and sell bread. The production approach sums these values added at each stage to prevent double counting, as only the final value of the bread is included in the GDP.
The general formula to represent this is:
GDP = sum of value added at each stage of production
What demarcates the production approach is its unique ability to highlight the contribution of different industrial sectors and the efficiency of the production processes within an economy. It also helps to pinpoint where economic activity is most vigorous, assisting in policy formulation and economic planning.