II.#B.

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

GDPt = Pt1Qt1 + Pt 2 Qt2 + Pt 3Qt3 + ..... + Pt N QtN .!

!
!

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.!
!
"

(1)!Consumption!(C)!

"

(2)!Investment!(I)!

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

Aggregate"Expenditure"
"

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

"
#(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)!
!

9!

!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),!!
10!

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!
!

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

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)"
!

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!

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

11!

(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!(Firms!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!

Investment!by!Private!sector!

(Public!investments)!

(Private!investments)!

(G!in!US)!

(I!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.!
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,!households!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!
#
#
#
!

12!

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"

RMB!
APPRECIATES!
RELATIVE!TO!US!

"
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.
!
b.

Financial!transactions!
Buying!and!selling!securities,!shares!in!the!stock!market,!government!transfer!payment.!
Underground!and!illegal!economic!activities!

13!

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!

"
"
"
"
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14!