Prerequisite: Understanding of the circular flow (refer to previous video on the topic).
The circular flow model is essential because it provides three different ways to measure economic growth.
Circular Flow Model
Shows the flow of income and expenditure in an economy.
Households provide factors of production (e.g., labor) to firms.
Firms produce goods and services, which are consumed by households.
Identifies leakages (savings, taxes, imports) and injections (investments, government spending, exports) but focuses on measurements of growth in this lecture.
Measurements of Growth
The circular flow helps to identify the flow of money in the economy.
Measuring economic growth involves assessing the changes in this flow year over year.
Three methods to measure economic growth:
Output Method
Income Method
Expenditure Method
1. Output Method
Also known as the Value of Goods and Services.
Measures GDP by calculating the value of all goods and services produced in the economy.
Focuses on the value added during production to avoid double counting.
Example: Copper mining and its transformation into wiring; consider only the value added at each stage, not the total value repeatedly.
Real GDP: The sum of all value-added goods and services.
Challenges: Risk of double counting.
2. Income Method
Measures the total level of incomes in the economy.
Includes incomes of firms, government, and consumers.
Total income equals total expenditure, aligning with the circular flow model.
3. Expenditure Method
Measures the total level of spending in the economy.
Calculated as: C + I + G + (X - M)
C: Consumer spending
I: Investment spending
G: Government spending
X - M: Net export spending
Aggregate Demand (AD) represents total expenditure and is another measure of economic growth.
Summary
All three methods (Output, Income, Expenditure) yield the same figure for economic growth.
**Key Points to Remember: **
Real GDP = Real Income = Real Expenditure.
Aggregate Demand (AD) and growth are synonymous.
Understand that these are different measures but ultimately provide the same information on economic growth.
Conclusion
These methods help in understanding and measuring the growth of an economy effectively.