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Three Approaches To Measuring GDP

1. There are three approaches to measuring GDP: the product approach, which measures output; the income approach, which measures incomes; and the expenditure approach, which measures spending. 2. These three approaches are equivalent ways of arriving at the total value of economic activity, even though they provide different perspectives. 3. In an example economy with two businesses - an orange grove and an orange juice maker - the product, income, and expenditure approaches all yield a total GDP of $50,000.

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260 views2 pages

Three Approaches To Measuring GDP

1. There are three approaches to measuring GDP: the product approach, which measures output; the income approach, which measures incomes; and the expenditure approach, which measures spending. 2. These three approaches are equivalent ways of arriving at the total value of economic activity, even though they provide different perspectives. 3. In an example economy with two businesses - an orange grove and an orange juice maker - the product, income, and expenditure approaches all yield a total GDP of $50,000.

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nikita_jageshwar23
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ThreeApproachestoMeasuringGDP

Thenationalincomeaccountsarebasedontheideathattheamountofeconomicactivitythat
occursduringaperiodoftimecanbemeasuredintermsof:
1. Theamountofoutputproduced,excludingoutputusedupinintermediatestagesof
production(theproductapproach);
2. Theincomesreceivedbytheproducersofoutput(theincomeapproach);and
3. Theamountofspendingbytheultimatepurchasersofoutput(theexpenditure
approach).
Eachapproachgivesadifferentperspectiveontheeconomy.However,thefundamental
principleunderlyingnationalincomeaccountingisthat,exceptforproblemssuchasincomplete
ormisreporteddata,allthreeapproachesgiveidenticalmeasurementsoftheamountofcurrent
economicactivity.
Wecanillustratewhythesethreeapproachesareequivalentbyanexample.Imaginean
economywithonlytwobusinesses,calledOrangeIncandJuiceInc.OrangeIncownsand
operatesorangegroves.Itsellssomeofitsorangesdirectlytothepublic.Itsellstherestofits
orangestoJuiceInc,whichproducesandsellsorangejuice.Thefollowingtableshowsthe
transactionsofeachbusinessduringayear.
OrangeIncTransactions
WagespaidtoOrangeIncemployees
Taxespaidtogovernment
Revenuereceivedfromsaleoforanges
Orangessoldtopublic
OrangessoldtoJuiceInc

JuiceIncTransactions
WagespaidtoJuiceIncemployees
Taxespaidtogovernment
OrangespurchasedfromOrangeInc
Revenuereceivedfromsaleoforangejuice

$15,000
5,000
35,000
10,000
25,000

$10,000
2,000
25,000
40,000

Whatisthetotalvalue,measuredindollars,oftheeconomicactivitygeneratedbythesetwo
businesses?Theproductapproach,incomeapproach,andexpenditureapproacharethree
differentwaysofarrivingattheanswertothisquestion;allyieldthesameanswer.

1. Theproductapproachmeasureseconomicactivitybyaddingthemarketvaluesofgoods
andservicesproduced,excludinganygoodsandservicesusedupinintermediatestagesof
production.Thisapproachmakesuseofthevalueaddedconcept.Thevalueaddedofany
produceristhevalueofitsoutputminusthevalueoftheinputsitpurchasesfromother
producers.Theproductapproachcomputeseconomicactivitybysummingthevalues
addedbyallproducers.
Inourexample,OrangeIncproducesoutputworth$35,000andJuiceIncproducesoutput
worth$40,000.However,measuringoveralleconomicactivitybysimplyadding$35,000
and$40,000woulddoublecountthe$25,000oforangesthatJuiceIncpurchasedfrom
OrangeIncandprocessedintojuice.Toavoidthisdoublecounting,wesumvalueadded
ratherthanoutput:BecauseJuiceIncprocessedorangesworth$25,000intoaproduct
worth$40,000,JuiceIncsvalueaddedis$15,000($40,000$25,000).OrangeIncdoesnt
useanyinputspurchasedfromotherbusinesses,sotitsvalueaddedequalsitsrevenueof
$35,000.Thustotalvalueaddedintheeconomyis$35,000+$15,000=$50,000.
2. Theincomeapproachmeasureseconomicactivitybyaddingallincomereceivedby
producersofoutput,includingwagesreceivedbyworkersandprofitsreceivedbyownersof
firms.Asyouhaveseen,the(beforetax)profitsofOrangeIncequalitsrevenuesof$35,000
minusitswagecostsof$15,000,or$20,000.TheprofitsofJuiceIncequalitsrevenuesof
$40,000minusthe$25,000thecompanypaidtobuyorangesandthe$10,000inwagesto
itsemployees,or$5,000.Addingthe$20,000profitofOrangeInc,the$5,000profitof
JuiceInc,andthe$25,000inwageincomereceivedbytheemployeesofthetwocompanies,
wegetatotalof$50,000,thesameamountdeterminedbytheproductapproach.

3. Finally,theexpenditureapproachmeasuresactivitybyaddingtheamountspentbyall
ultimateusersofoutput.Inthisexample,householdsareultimateusersoforanges.
JuiceIncisnotanultimateuseroforangesbecauseitsellstheoranges(inprocessed,liquid
form)tohouseholds.Thusultimateuserspurchase$10,000oforangesfromOrangeIncand
$40,000oforangejuicefromJuiceIncforatotalof$50,000,thesameamountcomputedin
boththeproductandincomeapproaches.

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