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Course: AP®︎/College Macroeconomics > Unit 2
Lesson 1: The Circular Flow and GDP- Circular flow of income and expenditures
- Parsing gross domestic product
- More on final and intermediate GDP contributions
- Investment and consumption
- Income and expenditure views of GDP
- Value added approach to calculating GDP
- Components of GDP
- Expenditure approach to calculating GDP examples
- Lesson summary: The circular flow and GDP
- The circular flow model and GDP
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Income and expenditure views of GDP
In this video we explore an alternative method of calculating GDP: the income approach. The intuition behind the income approach is pretty straightforward because every time you spend money, that spending is someone else's income. Learn more about the income approach and its categories: wages, interest, rent, and profit. Created by Sal Khan.
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Hi guys, i had a question based from an MCQ from an econ quiz i had today so, ill re-phrase it this way: if i purchase a car from someone else (not a firm and not mentioned whether its a new or an old car) will my expenditure be a part of the GDP or not? and why?(11 votes)
no, your car was counted when you bought it off of the lot. counting it again would be double counting the car. when you sold your car there are still the same number of cars in the world. You didn't produce a new car so you did not add to GDP.(82 votes)
- the video shows a view that the income is equal to the expenditure of a household ..isnt that too much of a simplification ...what if i save money and then spend ??...then will we have different GDPs??(15 votes)
This is a very simplified version, the more advanced ones will account for savings(11 votes)
- I have a question! Must total income equal total expenditure?
or will income be less than expenditure because some people don't spend all their income
or will expenditure will be greater than income because people can borrow money(13 votes)- Total income must match total expenditure in an economy, but differences can arise due to saving or borrowing.(1 vote)
Will GDP be same if calculated from both(income/expenditure) model ??(4 votes)
Technically, yes.
Because both methods represent two different approaches to calculating the same thing (i.e. a country's GDP), their results SHOULD (in a perfect world) be equal. HOWEVER, in practice the results are never equal (but usually pretty close). This happens because, well, measuring GDP is VERY, VERY HARD!
And, as EJON noted, the expenditure approach is often considered more reliable than the income approach.
(There's also a third approach, the "Output" approach--measured as Net Value Added of all business in a country over a given time period--which is usually considered to be the most reliable of the three, but I imagine Khan will mention that in a future video.)(8 votes)
What is expenditure?(7 votes)- Spending.
It's as simple as that.
In the next video, Khan will break down GDP into three parts (ignoring imports and exports):
1.) (Private) Consumption
2.) Investment
3.) Government spending
When people refer to total expenditure they are referring to the sum total of all spending (over a given time period) by consumers, investors, and the government.(2 votes)
How is saving accounted for? If the households save their income does not equal their expenditures.(3 votes)
Yes, but all of your expenditures are income for somebody else. When you spend money, someone else is getting that money as income. When you receive money as income, then that means that someone else is spending that money on you. So, even though an individual's income may be different from that individual's expenditures, aggregate income is equal to aggregate expenditures.(6 votes)
- Question again! are governmental transfer payments included in GDP and fall under Governmental purchases?
or not included in GDP because goods and services were not produced and transferred.(3 votes)- GDP in layman terms, is the overall expenditure on all finished goods and services produced in the economy. It's components are Consumer Expenditure, Government Expenditure, Investment and Net Exports. Government transfer payments like a welfare benefit is not included in the component Government Expenditure, because it's final transaction is by the consumer who spends the payment on goods and services. This would fall under Consumer Expenditure, otherwise if you included it in Government expenditure as well, it would be counted twice and this is not prudent.(5 votes)
Suppose,in an ultra developed country,there is no space or sector left for more growth,then how the country grow its GDP further and why it is a must to grow GDP for that country?(3 votes)
What would you consider to be ultra developed? Can you imagine the citizens of a country will say, this is just too much money, I cannot spend it all, so I will not try to make more money in the future.
If this ever happens, people will stop thinking about more efficient ways to produce goods and services. This will be the time, when a country will be ultra developed and its economic growth will stop.
I do not thing economic growth will ever stop since people will always want to have more wealth and their creativity will always be there for them to think of new and better ways of creating wealth.
Just think of what we see today. We have such a high standard of living which was unimaginable a few hundred years ago. We still feel we want more.(5 votes)
- What are firms, exactly? I hear the word thrown around a lot but have never really seen a good definition of the word.(1 vote)
A firm is not a household. Basically, in economics a firm is most generally referring to a company, a corporation or a producer of goods or services.(9 votes)
What do you mean when you say household? and are firms the production?(2 votes)
Households are essentially people, natural people. One household may be a person or a group of people. As a simplification, it is assumed that there is only one stream of income for a household.
Firms are not the production itself, but they are the organizations associated with the production, that provide goods or services that account for GDP.(2 votes)
Video transcript
You'll hear people talking about different ways of looking at GDP and in general they will talk about the expenditure view of GDP. The expenditure view of GDP vs. the income view of GDP and to realize why these get you to the same number for GDP But why you're kind of conceptually looking at 2 different things, we're gonna revisit a very very simple economy- maybe slightly more complicated than that one island economy. So in this economy, we have some households, and that's why it's slightly more complicated, because I am talking about households, not just one house on an island. You have some households and you have some firms. And for the sake of simplicity, we're going to assume that households own all the factors of production. And they essentially rent them out to firms to produce all the goods and services. The firms, and this is another assumption, produce all the goods and services. These are two very strong assumptions and these really are not true in the real world. This just helps me draw the diagram. Obviously in the real world, households do not own all the factors of production. Many, if not most of the factors of production the factories and the ships and whatever else are actually owned by firms in the real world but this is not that crazy an assumption because those firms, at the end of the day are owned by people, they are owned by households. So in theory, that they could have been transferred to the households and then the households just rent the factors of production to the firms. And this is also a hugely simplifying assumption because we know that in the real world, we know that firms don't produce all the goods and services, households also produce goods and services, some of which, never get measured. The service for me taking the trash out at night, or doing the lawn, or making dinner or the service of parents taking care of their children. None of that gets accounted for. But for this, just for simplicity, we're going to make these two assumptions. All the factors of production and the system. The labor, the land, the capital, and if we wanna throw it in, the entrepreneurship, it's all loaned by households and all goods and services are produced by firms. So just like we saw with that first example of the island, the households do all of the expenditures, and these ends up being all of the revenue for the firms. And then the firms spend a lot take that revenue and then spend it to rent many of these factors of production or some or all of these factors of production so they hire the people, which is essentially they're renting labor, they might rent the land, they might rent the capital, so all of that ends up becoming income for the households. And whatever else is left over, so this is expenses. So if we take this revenue, what it turns into is expenses and profit. Whatever's leftover after expenses is profit. We're assuming all the firms are also owned by all the households so the expenses plus the profit end up all going to the households and becoming income, which then becomes expenditures for the households, which then become revenue for the firms. So when people say the expenditure vs. the income view of GDP, they're saying "look, I can measure GDP at any one of these points." I could measure the expenditures at a time period by households, in this very simple model which would be the same as the revenue of firms in this very simple model, which is the same as expenses plus profit of the firms in this simple model, which is same as the income of the household. and so, the expenditure view of GDP would be looking in this very simple model, you see, it gets very complicated very fast, especially when we start thinking about expenditures, not just coming from households, but this is simplifying, hugely simplified model to show you that these are the same thing, and say "hey, look at GDP at this point, maybe at that point". If you wanna look at the income model, you can look at GDP at that point. What we'll see as we go into future videos, as we break things between consumption and investment and government spending and net exports, that it isn't quite this simple to diagram out, but when we do think about that, we are thinking when we are thinking about consumption and investment and government, we are thinking about it from the expenditure point of view. There's another way of thinking about it, where you could have looked at the aggregate income in that country's point of view making some adjustments for things like exports and imports and things like that. But hopefully at least this clarifies why these come up with the same number from what you can see in this very simple model and that there are two slightly different lenses on the same thing.