! 9!

II.#B.#Expenditure#Approach#

#

Conceptually,!!the!GDP!of!a!country!in!time!period!t!is:!

!

!Nt

Ntttttttt QPQPQPQPGDP ++++= .....332211

.!

!

In!practice,!we!can!compute!the!GDP!by!the!aggregate!expenditure!that!has!occurred!for!the!goods!and!

services!produced!in!the!country!in!time!period!t!(Expenditure!Approach).!We!can!classify!the!aggregate!expenditure!into!4!main!categories.!

!

"

"

"

Aggregate"Expenditure"

"

"

#(1)#Consumption#(C)#[Personal#Consumption#Expenditure#(PCE)]##

total!expenditure!on!consumption!of!goods!and!services!by!domestic!households!!

• goods:!! ! durables!and!nondurables!(residential!properties!not!included)!

• services:!! e.g.,!medical!care,!education,!haircuts!

(2)#Investment#(Gross#Private#Domestic#Investment)#(I)#

There!are!two!main!groups!in!this!category:!

(a)!total!expenditure!on!the!residential!properties!in!the#first#hand#market!by!domestic!!

!!!!!households,!!(only!when!it!is!purchased)!

(b)!total!expenditure!on!investment!by!firms!operating!in!the!country.!

Total!expenditure!on!investment!by!firms!includes:!

(i) business!fixed!investment!

capital"goods"in"the"first"hand"market:"e.g.,""factories,"warehouse,"machines,"trucks"etc."

(for!londHterm)!

(ii) changes!in!business!inventory!!

!!!market!value!of!business!inventory!(end!of!the!period)!

(1)!Consumption!(C)!

(2)!Investment!(I)!

(3)!Government!Purchase!(G)!

(4)!Net!Export!(NX)!

! 10!

!H!market!value!of!business!inventory!(beginning!of!the!period)!

• inventory!refers!to!the!goods!that!have!been!produced!but!not!yet!sold!

Numerical!Example!

!

! Market!Value!of!Inventory!

Beginning!of!2009! $10,000!

End!of!2009! $15,000!

Change!in!Inventory! $5,000!(!=!$15,000!H!$10,000)!

!

The!Change!in!Inventory!in!2009!($5,000)!will!be!counted!as!Investment!in!2009.!

“Investment”*here*is*the*real*investment*NOT*financial*investment.*

Financial!Investment!is!investment!in!financial!assets!like!stock,!bonds,!etc.!

!

Real:!physical!capital!goods,!physical!goods!in!inventory!

Financial!assets:!change!in!ownership;!nothing!to!do!with!production!

(3)#Government#Purchase#of#goods#and#services#(G):#

expenditure!of!the!domestic!government!on!goods!and!services!!

Examples:!cameras!for!taking!ID!photos,!furniture!in!government!offices,!!

!!!!!!uniform!for!police,!police!salary!

Note:!The!expenditure!of!the!government!can!be!classified!into!two!groups,!those:!

• for!the!purchase!of!goods!and!services!(examples!above),!and!

• NOT!for!the!purchase!of!goods!and!services!(transfer!payments).!

Examples!of!“Transfer!Payments”:!!

• Comprehensive!Social!Security!Assistance!Scheme,!!

• Social!Security!Allowance!(for!elderlies!with!age!of!65!or!above).!

(these!are!irrelevant!to!production!of!goods!and!servces)!

(4) Net#Export#(NX)#

So!far,!in!Aggregate!Expenditure,!we!have!considered!!C!+!I!+!G.!

The!C,!G,!and!I!may!include!goods!and!services!produced!by!foreign!countries!(imports;!IM).!

Examples!of!imports:!! CDs!of!Korean!Pop!Singers,!Mercedes!(from!Germany),!!

! 11!

! ! ! Sony!Notebook!(from!Japan)!

Hence,!to!evaluate!expenditure!of!goods!and!services!produced!domestically,!we!should!subtract!imports!

from!the!above!expenditure!items:!

C!+!I!+!G!!!!!!H!IM!

Also,! there!can!be!goods!and!services!produced! in! the!country!but! sold! to! foreign! firms,!households!or!

government!(exports;!EX)!:!they!do!not!show!up!in!C,!G!and!I.!!

Examples!of!exports:!! CDs!of!local!artists!sold!in!Canada,!!!

expenditure!of!foreign!visitors!on!lodging!or!hospital!services!in!Hong!Kong!

Hence,!to!evaluate!expenditure!of!goods!and!services!produced!domestically,!we!should!add!them!to!the!

above!expenditure!items:!

Aggregate!Expenditure!!=!C!+!I!+!G!+!EX!!!H!IM!

Let!! Net!Export!(NX)!=!Export!–!Import!=!EX!H!IM!

Aggregate!Expenditure!!=!C!+!I!+!G!+!NX!

GDP!=!Aggregate!Expenditure!on!the!final!goods!and!services!produced!in!the!country!

!

Thus,!!

#

II.C.# Does#the#composition#of#the#GDP#(expenditure#approach)#vary#across#countries?#

What#information#can#we#obtain#from#the#composition?##

!

Table!2.!Composition!of!GDP!(Expenditure!Approach)!(%!of!GDP),!2010!

Source:"US" (p."294" text);"China" (Wikipedia"based"on"China"Statistics"Yearbook);"HK" (Census"and"Statistics"Department,"HK)"

#

Using#the#composition#of#the#GDP#to#analyze#an#economy#

! US## HK## China##

Consumption# 70.5! 62.6! 35.0!

Investment# 12.4! 23.5! 48.1!

Government# 20.7! 8.4! 13.2!

NX# H!3.6! 5.5! 3.7!

Total# 100! 100! 100!

GDP!!=!C!+!I!+!G!+!NX!

! 12!

(1)"Refer"to"Current"Issues:"reading"2"

C/GDP!*100%!H!job!market!information?!(try!to!find!the!relationship!and!quantify!it)!

Government!structure!and!identify!source!of!growth!

Private!investment!(Firm’s!profit?)!

Government!(ability!to!spend?)!

Net!export!(foreign!economy?)!

(2) Refer"to"Table"2"above"

! Government!Purchase!of!goods!and!services! !

Investment! Government!purchase!of!capital!goods!

(Public!investments)!

(G!in!US)!

(I!in!China!and!HK)!

so!it!seems!that!G!in!US!is!higher!than!the!others!

while!China!and!HK!have!higher!I.!

Investment!by!Private!sector!

(Private!investments)!

(I!in!US)!

Government!

expenditure!

Government! purchase! of! consumption! goods! and!

services!

(G!in!US)!

(G!in!China!and!HK)!

!

!

Observations:!

Investment!in!China!

Consumption!in!China!

Concern:!

Over!investments!(eg.!Properties)!

If!eventually!property!price!drops,!household’s!wealth!will!drop,!then!consumption!and!investment!will!

drop.!!

This!will!lead!!to!recession!in!economy!

Soft!landing!&!Hard!landing!–!China!maybe(many!Asian!countries)!

Chinese!Government:!tries!to!encourage!domestic!consumption!

#

#

#

! 13!

Remark:#

Be"careful"when"we"compare"the"GDP"of"different"economies"

(Refer"to"Table"1"on"p."1"of"this"Handout"or"Current"Issues"Reading"(1))"

"

We!convert!the!GDP!in!domestic!currency!into!a!common!currency!in!order!to!compare!the!gap!

Fluctuations!in!the!exchange!rate!can!affect!the!results!

RMB"100"="US"14"

RMB"100"="US"16"

"

Even!if!there!is!no!change!in!the!GDP!of!Chin!in!RMB!

A#pure#appreciation#of#the#RMB#relative#to#US#can#increase#the#GDP#of#China#in#US#$#

!

GDP!will!exclude!from:!

a. Financial!transactions!

! Buying!and!selling!securities,!shares!in!the!stock!market,!government!transfer!payment.!

b. Underground!and!illegal!economic!activities!

RMB!

APPRECIATES!

RELATIVE!TO!US!

! 14!

III.## Other#approaches#–#Income#approach#and#Production#approach#

All!approaches!are!made!use!of!the!simple!circular!flows!

It!is!assumed!there!is!no!government!in!the!economy!

It!is!a!closed!economy!without!international!trade!

Total!output!=!Total!income!=!Total!expenses!

What! if! there! is! output! being! produced! but! not! consumed! –! it! is! considered! as! the! firm! buying! its!

inventory!(Concept!of!changes!in!inventory)!

A. Income!approach!

Add!up!the!in!come!from#all#firms#not!just!the!final!good!producing!firms!

B. Production!approach!

Value!adding!

"

"

"

"

"