Question

$$\begin{array}{lr} \text { Item } & \text { Billions of dollars } \\ \hline \text { Wages } & 8,000 \\ \text { Consumption expenditure } & 10,000 \\ \text { Other factor incomes } & 3,400 \\ \text { Investment } & 1,500 \\ \text { Government expenditure } & 2,900 \\ \text { Net exports } & -340 \end{array}$$ Explain the approach (expenditure or income) that you used to calculate GDP.

Short answer

GDP using expenditure approach is 14,060 billion dollars. GDP using income approach is 11,400 billion dollars.

Step-by-step solution

- Choose an Approach

To calculate the GDP, either the expenditure approach or the income approach can be used. Both should give the same result.

- Define the Expenditure Approach

The expenditure approach to GDP sums up all expenditures made in an economy within a certain period. The formula is: \[ \text{GDP} = C + I + G + (X - M) \] where C = Consumption expenditure,I = Investment,G = Government expenditure,X = Exports,M = Imports.

- Calculate GDP Using Expenditure Approach

Substitute the values into the formula:\[ \text{GDP} = 10,000 + 1,500 + 2,900 + (-340) \]Calculate the result:\[ \text{GDP} = 14,060 \text{ billion dollars} \]

- Define the Income Approach

The income approach to GDP sums up all incomes earned in an economy within a certain period. The formula is: \[ \text{GDP} = \text{Wages} + \text{Other factor incomes} = 8,000 + 3,400 \]

- Calculate GDP Using Income Approach

Substitute the values into the formula:\[ \text{GDP} = 8,000 + 3,400 = 11,400 \text{ billion dollars} \]

- Compare Both Results

Both approaches should theoretically give the same result. However, because there might be statistical discrepancies, these results may differ slightly.

Key concepts

Expenditure Approach

The expenditure approach is a method used to calculate GDP by summing up all expenditures made within an economy during a specific period. This approach considers four main components:

• Consumption Expenditure (C): This is the total value of all goods and services consumed by households.
• Investment (I): This includes business investments in equipment and structures, residential construction, and changes in business inventories.
• Government Expenditure (G): This refers to the total government spending on goods and services.
• Net Exports (X - M): This is the value of a country's exports minus its imports.

The expenditure approach formula for GDP is: \[\text{GDP} = C + I + G + (X - M) \]By substituting the values given in the problem into the formula, we get: \[\text{GDP} = 10,000 + 1,500 + 2,900 + (-340) = 14,060 \text{ billion dollars}\]This total represents the GDP calculated using the expenditure approach.

Income Approach

The income approach to calculating GDP sums up all incomes earned by individuals and businesses within the economy over a specific period. This method includes two main components:

• Wages: The total remuneration paid to employees including salaries, wages, and other compensations.
• Other Factor Incomes: This includes profits, rents, and interest incomes earned by businesses and individuals.

The formula for the income approach is: \[\text{GDP} = \text{Wages} + \text{Other Factor Incomes}\]By substituting the given values into the formula, we arrive at: \[\text{GDP} = 8,000 + 3,400 = 11,400 \text{ billion dollars}\]This total represents the GDP calculated using the income approach. Although it may differ from the expenditure approach due to various factors, both methods are used to capture the overall economic activity.

Net Exports

Net exports measure the value of a country's total exports minus the value of its total imports. This figure is crucial in the expenditure approach when calculating GDP.Net exports can be a positive or negative number:

• Positive Net Exports: When a country exports more than it imports, leading to a trade surplus, adding to the GDP.
• Negative Net Exports: When a country imports more than it exports, leading to a trade deficit, reducing the GDP.

In the given problem, net exports are: \[\text{Net Exports} = -340 \text{ billion dollars}\]This indicates the country has imported more than it exported within the specified period. Negative net exports (a trade deficit) reduce the overall GDP when using the expenditure approach.

Statistical Discrepancies

When calculating GDP using both the expenditure and income approaches, it is common to encounter a discrepancy between the two results. These differences are known as statistical discrepancies. The reasons for these discrepancies can be numerous:

• Measurement Errors: Data collection inconsistencies, rounding off errors, and differences in recording methods.
• Timing Differences: Variations in the timing of when income is earned versus when expenditure occurs.
• Unreported Economic Activity: Activities not captured in official records, such as informal or illegal economic transactions.

In the problem, the expenditure approach gives us a GDP of 14,060 billion dollars, whereas the income approach results in a GDP of 11,400 billion dollars. While ideally, both methods should yield the same outcome, these statistical discrepancies highlight the complexities in real-world GDP calculation and the need for adjustments and reconciliations to harmonize the results.