The Circular Flow and GDP
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Expenditure approach to calculating GDP examples
- [Instructor] What I hope to do in this video is even more examples to make sure we really understand how various things would be accounted for in the expenditure approach to GDP. Now we have talked about this in other videos. There's many different ways of calculating GDP, but in the expenditure approach, you can break it down as being made up of consumption by households plus investment by firms plus government spending on goods and services, by the government, and net exports. And so with that out of the way, pause this video and look at each of these statements and think about what effect would it have on GDP if we have the expenditure approach and how would it be accounted for in these various categories. Okay now let's work through this together. So this first scenario it says Ford pays $1 million for a U.S.-made robot for its factory in California. So we have a firm right over here. It is Ford. And it's investing in physical capital. And in most cases, well especially if you're looking at some type of a standardized test on an AP exam, investment is firms investing in physical capital, although it can also be on intellectual capital, things like software. But this is very clear, it's Ford buying a U.S.-made robot, physical capital. This robot is going to help Ford make more cars or trucks or whatever it's trying to make. So this is a very clear that it would increase GDP, so GDP would go up, by $1 million because of this, $1 million. And the place that it would be accounted for is in investment. So I could say investment would go up $1 million. Or the reason why GDP goes up $1 million or you would add $1 million to GDP is because you would add $1 million to investment. This is a clear investment by a U.S. firm. All right now let's look at the next scenario. A U.S. car rental company spends $1 million to buy 30 new Fords that were made in the U.S. So pause this video again see if you can think of that. Well this is a very similar scenario. A U.S. car rental company, and it is investing in physical capital right over here. By buying those 30 new Fords, it can rent those out to create future benefit. And so once again it would be the same thing. In that first case, GDP would go up by a million because investment goes up by a million, and in this case as well, GDP would go up by $1 million because investment went up by $1 million. Now let's look at this third scenario. A U.S. car rental company spends $1 million to buy 30 new Toyotas that were made in Japan. So how is this different? Well in this scenario, you still would have a U.S. firm investing in physical capital, it's spending $1 million. So you actually would, you would actually have investment go up by $1 million. But it's not investing in things that are made in the United States. It's investing in things that are made in Japan. So in this particular scenario, it will be counteracted by net exports. Here we are importing $1 million worth of things, and so that would take net exports, so net exports would go down by $1 million. A $1 million import is the same thing as a negative $1 million net export. And so because of these two, this will have no impact on GDP. No impact on GDP. And the reason why this makes intuitive sense is remember GDP is supposed to measure how much a, how much was produced, and in this scenario a car rental company is investing but it was produced someplace else. It wasn't produced in the United States. Now this third scenario, a Japanese car rental company spends $1 million to buy 30 new Fords that were made in the United States. So this is almost a symmetrically opposite scenario. So we would not add to investment here because this was a Japanese car rental company and we're calculating GDP for the United States or at least that's the assumption. But because the U.S. would export these 30 new Fords for $1 million, that would add to net exports. So in this case, net exports, let me do the net export color, net exports would go up by $1 million. And because net exports went up by $1 million and nothing else here is impacted, GDP, GDP would go up by $1 million. And once again the reason why this makes sense is United States produced $1 million worth of stuff. It happened to export them out, and that's where it got accounted for, but definitely GDP is $1 million higher because of this. So this next one is interesting. You buy $100,000 of IBM stock. What do you think this is? Pause this video again. So you in traditional language, you might say I invested $100,000 of IBM stock. But I'm a household, so how does this work? Well it turns out that this does not move any of these dials right over here because at least the assumption here is that you are buying that $100,000 of IBM stock from someone else. It is not, it is not because something is being made in the United States, there's some new productivity that's happening. And so even though in everyday language we sometimes think of this as in investment, this has no impact on any of these categories. So no, no impact. And I really wanna emphasize that. Investment is sometimes associated with things like buying stocks, but investment in the GDP sense is when a firm is buying some type of capital that'll give it some future benefit, help it make things better. Oftentimes it's physical capital. More and more it's often things like software or some type of intellectual capital. Microsoft buys $100 million of IBM stock. This one might be even more tempting to put in the investment category because Microsoft for sure is a firm, and it looks like it's investing in another firm. But once again, Microsoft isn't buying some type of physical machinery or it isn't buying an accounting system or some type of intellectual capital. It's just buying shares from someone else. So once again nothing new is being produced in the country, so this has no impact. I really wanna emphasize these last two because this shows up on some exams where it says oh this kinda feels like an investment, at least in everyday language, so people would account for it there. But remember, no new capital. Microsoft isn't buying something that's going to help Microsoft produce more of whatever Microsoft is trying to produce. All right this next one, the Social Security Administration makes a $2,000 payment to a retiree. What do you think's going on there? So you might be tempted to say hey that's a government expenditure, the Social Security Administration, they're spending $2,000. But we have to remind ourselves, this G category is government expenditure on goods and services, not a transfer payment like this. And so this would have no, no impact. Another intuitive way to think about it, and we've been talking about this for awhile, nothing new is being produced in the United States because of this payment. Now we can contrast that with the next scenario right over here. The Social Security Administration buys a new accounting system. Well in this scenario, the government is buying a good or service. It might be a combination of both. They might have to buy some computers, some software, maybe hire some consultants to implement it for them. So it is the government paying for goods and services. So in this situation, our government category would go up by however much they're spending. Let's say they spend, let's say this was I don't know $1 million again. So then the government would, the government category would go up by $1 million because it's a good or service it's spending, and because of that GDP would go up by $1 million. Hopefully you enjoyed that.
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