Income Method Video Lecture | Business Economics for CA Foundation

hello everybody in today's video lecture
we're going to be talking a little bit
about macroeconomics specifically the
measurement of gross domestic product in
this activity we'll be talking about the
circular flow of the nation's economy
and we'll discuss the two different ways
the nation's GDP can be measured using
either the income approach for measuring
GDP or the expenditure approach we will
apply these two methods for measurement
to the circular flow that we see here
let's begin by defining gross domestic
product more clearly one way to measure
GDP is by using the income approach the
income approach measures the total
income earned by the households in a
nation during a year let's look at our
graph here and decide where the income
in the circular flow is shown any
circular flow model includes two markets
it includes households and firms
households are the providers of
resources to firms who demand resources
in order to produce goods and services
as we've seen our circular flow here
households provide land labor and
capital to firms in the resource market
in exchange for the provision of these
productive resources households receive
income in the form of wages interest and
rent but before we get into the income
approach let's define the other way that
GDP can be measured another way to
measure gross domestic product is by
finding the total amounts spent on the
goods and services produced in the
nation by households firms the
government and foreigners this is known
as the expenditure approach expenditure
is another way of saying spending
therefore the expenditure approach
measures the total amounts spent on the
nation's goods and services let's look
at the circular flow model again and
find out where the expenditure approach
can be seen in this graph let's look in
the product market now households spend
money in the product market for which
they receive goods and services of
course households are not the only ones
consuming a nation's products
firms also consume products in the form
of capital goods and governments consume
products in the product market in the
form of infrastructure goods services
such as healthcare education and
national defense let's go into more
detail about the income approach now and
find out how we can find the total
income in a nation therefore the total
GDP by breaking down the different types
of income earned by households by
providing their productive resources to
firms in the resource market households
can earn several different types of
income as we know the different
resources that households provide to
firms are land labor capital and their
entrepreneurship for each of these types
of productive resources households
receive money incomes in return for land
households receive rental income
therefore the payment that households
received for land is called rent an
example of this is a farmer who owns his
own land yet he rents it out to a
corporation that farms wheat on his land
the corporation is paying the landowner
rental income for the permission to use
his land to grow wheat on next let's
talk about labor labor seems fairly
obvious a worker is somebody who goes to
work every day provides a labor of some
sort whether it's manual labor or
intellectual labor either way households
provide workers for firms in exchange
for their labor households earn what we
call wages wages are the payment
households receive in exchange for their
labor wages could be high wages if a
person is providing a particularly
valuable type of labor such as medical
services or that could be low wages
different individuals providing lower
skilled labor such as construction work
or menial services either way the wages
a household earns are considered the
income they earn in exchange for their
labor resource next let's talk about
capital capital is a little bit more
difficult to understand
first we'll identify the income received
in exchange for their capital households
receive interest payments in exchange
for their capital resources to explain
this we need to look at one of the
components of our circular flow diagram
here and that
is the banking sector so let's look over
here at the banking sector and we can
determine how households receive
payments in exchange for their capital
as you know many households like to save
money
of course savings is considered a virtue
when households save money there is a
leakage from the circular flow of income
this is because a penny saved is not a
penny spent therefore there is less
spending on goods and services when
households save however money saved is
not wasted money saved in banks is
invested by those banks who loaned that
money back to business firms which need
to borrow money to acquire capital
equipment to pay their workers and to
cover other costs of production when a
business firm borrows money from a bank
to operate its business it pays the bank
interest in return for the privilege of
borrowing that money of course whose
money are the firm's borrowing
ultimately the money being borrowed
belongs to households who have savings
at that bank and that way households
that save money at banks receive
interest payments in return for the bank
lending that money to business firms so
savings is considered a leakage from the
circular flow but it is savings that
enables firms to invest in capital
equipment
therefore investment is considered an
injection into the circular flow as we
see on the graph here that's why the
green arrow from investment points into
the circular flow model sorry the yellow
arrow but the green highlighted arrow
here is a leakage in the form of savings
households receive interest payments for
money that they save at banks banks earn
that interest by lending that money to
firms and that way firms are able to
acquire capital using money lent to them
through the banking system that
ultimately belongs to households that
leaves us with entrepreneurship
households some households are
entrepreneurs these are the business
owners these are the business owners who
seek profits by opening a business of
their own starting a business enterprise
if a household starts his or her own
business they are ultimately seeking
profits therefore the income earned by
households
who start their own business is known as
profit if we take the total rents wages
interest payments and profits earned by
households we get the total income of
the nation which when some together will
give us the GDP or the gross domestic
product of the nation in this way the
income approach measures the total rent
wages interest in profits earned by
households to find the total income
earned in the resource market in the
nation in here next let's talk about the
expenditure approach of measuring GDP as
I explained before expenditures is
another word for spending in this way
the expenditure approach of measuring
GDP sums the total amount spent on goods
and services produced in the nation
spending occurs by households by firms
by the government and by foreigners
let's talk about each of these one at a
time when households spend money on
goods and services
this is considered consumption or
capital C in our simplified equation
consumption includes all spending by
households on goods and services but
with this money income as we see in our
graph here the money returns to firms in
the form of consumption in the product
market the next type of expenditure that
occurs in a country is spending by firms
on capital goods
this we call investment now when we use
the word investment here we're talking
about a very particular type of
investment for example if I said that I
am investing in my education by paying
for private school tuition this is
technically not investment from an
economic standpoint because what I'm
really doing is paying tuition and bind
the service of education in the product
market hence spending money on private
school education is actually a form of
consumption investment from a
macroeconomic standpoint includes all
spending by firms on capital goods so we
can just call investment capital
spending by firms of course capital
goods means the tools the technology
used in the production of goods and
services whenever a firm buys a new
piece of technology or capital this is
considered investment the next
stakeholders who spend
money nation's economy are the
government we simply call this
government spending what types of things
to government spend money on this may
include education such as public schools
infrastructure such as roads and bridges
government spending may also include
spending on health care for the elderly
or for the unemployed or for the poor
households in the nation anytime a
government provides public goods to the
nation's firms or households this is
considered government spending and it is
therefore an injection into the nation's
circular flow but this raises the
question where does government get the
money to spend on goods and services for
the nation's households and firms of
course as anybody who has ever filed
taxes and earned an income knows tax
money spent by households and firms go
to the government sector to allow them
to provide the goods and services that
firms and households benefit from
therefore taxes are considered a leakage
from the circular flow whereas
government spending is considered an
injection into the circular flow this
leaves one final stakeholder when
considering the different types of
spending that can go on in the nation
and that is foreigners foreigners by a
nation's exports let's look again at our
model here we have the foreign sector in
the upper left hand corner in the
foreign sector money spent by foreigners
on our nation's exports are considered
an injection into the circular flow this
is because foreigners who earn their own
incomes in their own resource market are
choosing to spend some of those
hard-earned incomes on our nation's
goods this leads to an increase in our
nation's GDP since there is money
flowing into the economy but that raises
the question what if somebody in our
nation buys a good from abroad in other
words buys an import of course naturally
any money spent on imports within our
nation has to be subtracted from the GDP
this is because imports spending is
considered a leakage from the circular
flow that's why the arrow points out of
the circular flow model if I buy a
t-shirt made in China then the money I
spent on that t-shirt goes to a Chinese
household not to an American household
or in my case a Swiss house
since I live in Switzerland so here we
have the four different types of
expenditures that occur in a country
these can be summarised as C plus I plus
G Plus X which stands for exports minus
M which stands for imports if we add
these together we get the nation's GDP
this is known as the expenditure
approach and the GDP found by finding C
plus I plus G Plus X minus M gives us
the total expenditures in a nation in a
year now why does the total income of a
nation equal the total expenditures
because that's really what we're saying
here we're saying that the GDP
regardless of how it is found will equal
the sum of either wages rent interest in
profits or consumption investment
government spending and exports minus
imports here we can see that any money
earned by households in the resource
market ultimately is spent by households
in the product market therefore income
earned is money spent income equals
expenditures now households are not the
only ones spending money in a country so
what about money spent by domestic
households on foreign goods if
households buy imports from another
country why does this money always come
back to the country from which those
households are spending well the answer
there is that money spent by let's say
an American household on a t-shirt made
in China of course I'm spending US
dollars on that t-shirt so money earned
by the Chinese firms or sorry the
Chinese firms and households who produce
that t-shirt the only where the way
those US dollars can be spent as if it
comes back to the United States in the
form of exports for the United States in
this way a leakage in the form of import
spending turns into an injection in the
form of export sales the same goes for
investment if households save money and
banks ultimately that money will be
rejected into the economy through
investment so thus the banking sector
also has leakages and injections the
same goes for government spending if cut
if households and firms pay taxes to the
government
to the time this tax money will be spent
again on public goods for households and
firms by the government so any income
earned some of which is spent on
domestic goods some of which is used to
buy imports some of which is used to pay
taxes with and some of which is saved
ultimately turns into expenditures or
spending in the form of government
spending investment by firms and the
purchase of exports by foreigners in
this way the total income earned in a
nation is equal to the total
expenditures from all stakeholders on
that nation's goods and services and
thus we have a complete circular flow
and two different ways to measure GDP