Show that the expenditure approach and income approach add up to the same figure
To show that the expenditure approach and income approach add up to the same figure, we need to understand what each approach measures.
The expenditure approach calculates the GDP (Gross Domestic Product) by adding up all the spending on goods and services within an economy during a specific period. It includes four main components: consumption (C), investment (I), government spending (G), and net exports (NX).
The formula for calculating GDP using the expenditure approach is:
GDP = C + I + G + NX
The income approach, on the other hand, calculates GDP by summing up all the incomes earned by individuals and businesses within an economy during a specific period. It includes various types of income, such as wages, salaries, profits, and rents.
The formula for calculating GDP using the income approach is:
GDP = Compensation of Employees + Gross Operating Surplus + Mixed Income + Taxes on Production and Imports - Subsidies
Now, to demonstrate that the expenditure approach and income approach add up to the same figure, we can break down the components involved.
1. Consumption (C): This represents the spending by individuals and households on goods and services. It includes items such as food, clothing, housing, and healthcare.
2. Investment (I): This refers to spending on capital goods, such as machinery, equipment, and structures, and also includes changes in inventories.
3. Government spending (G): This includes expenditure by governments on public goods and services, such as infrastructure, defense, and education.
4. Net exports (NX): This represents the difference between exports (goods and services produced domestically and sold abroad) and imports (goods and services produced abroad and purchased domestically).
When we calculate GDP using the expenditure approach, we add up all these components, representing the total spending in the economy.
On the other hand, the income approach calculates GDP by summing up all the incomes earned by individuals and businesses. This includes wages and salaries paid to employees, profits earned by businesses, rents from land and real estate, and various types of taxes and subsidies.
Since all the income in an economy ultimately comes from the spending on goods and services, the sum of incomes earned by individuals and businesses must be equal to the total spending (expenditure) in the economy (GDP). Therefore, the expenditure approach and income approach will give us the same GDP figure.
In conclusion, the expenditure approach and income approach are two different methods of calculating GDP, but they yield the same result because they capture different aspects of the economic activity within an economy. By measuring either the total spending or the total income, we can arrive at the same figure for GDP.