Circular Flow and GDP: Don't Count Items That Would Inflate The Value of The Economy, or "Double Count"

Circular Flow and GDP
Circular Flow Model
Versions of the flow chart exist in all texts. The goal is to show how components of economies inter-connect.
Here are the basic premise points:

Firms/Businesses connect with Households by turning factors into goods and services.
“Factors” = The basic economic factors of production.
Firms make goods and services by hiring households to provide labor.
Firms and Households in domestic economies connect with international/foreign markets through exports and
imports.
Governments create goods and services by collecting some taxes and services from both firms and households.
GDP
Gross Domestic Product
“Gross” means the number before the effect of inflation is calculated on the value of items.
It is the basic measure of how much is produced annually by the circular flow chart or the national economy.
GDP measures the value of goods AND services
GDP versus GNP

Until the early 1990s, the US government calculated the value of the economy by using Gross National Product.
This calculates the value of all goods and services produced by US owned companies without regard to the location
of the factories. As outsourcing of manufacturing increased, GNP became a less reliable measure of the health US
domestic production.
Therefore, GDP is now used which counts all production completed within the US without regard to the parent
company’s country of origin.
GNP is still calculated, but GDP is the measure that signals domestic expansions or recessions.
Expenditure Approach
The most common calculation and is found on every test in some form!
Logic: The economy is as big as what we are able to spend annually on goods and services
C + Ig + G + Xn (Xn is also listed as X-IM in some texts)
C = Private consumption of goods and services (in the US, this is usually around 67% of GDP)
Ig = Private investment in (often around 16% of the US economy)
maintaining factories (covering the depreciation of equipment that wears out),
building new factory equipment,
holding unsold product inventory at end of a calendar year
building new houses (Houses are not regular “products”. They don’t have to lose value.)
G = Government spending on goods and services (often around 20% of the US economy)
Xn = The value of net exports (money coming in to the country) minus the value of imports (money leaving).
Since the US imports more than is exports, the Xn is usually -2 to -3 % of the economy per year.
Don’t count items that would inflate the value of the economy, or “double count”:
 Intermediate goods = Items only created to be part of something else as a final good
 Used goods = Even though they have value, they are not new production
 Banks transfers, stocks and bonds =The money will be used later for expenditures of goods and services
 Unreported cash activities = Legal and illegal cash that isn’t reported to tax agencies but is used later for
purchases
 Public and private transfers like gifts and public assistance = Again, the money will be used later for
purchases.
 The “value” of family work or volunteer work.
Does it count in GDP using the Expenditure Approach?
If it doesn’t count, check in the No column
If it does count, check the Yes column and list which part of GDP it counts in: C or Ig or G or Xn?
No Yes C, Ig,
G, or
Xn?
1. You purchase a newly built home as the first owner.
2. You purchase a used home that is priced twice as much as nearby new homes.
3. You pay a high schooler on your block to come over and re-configure your
laptop.
4. You pay your son to babysit the younger children for an afternoon.
5. A local engineering company buys new computer stations for all employees.
6. You purchase an expensive 19th Century painting as an investment.
7. The federal government buys concrete for highway construction.
8. Chase bank makes massive profits from FFR loans to other banks.
9. Dell Computer Inc. provides tech support for European Dell owners.
10. Ford makes 100 trucks in December of this year, but they might sell next year.
11. A college student receives $1000 from grandparents for textbooks (all 2
books!).
12. A refinery spends $100 million to repair aged pipes in the production system.
13. A US t-shirt company buys all its cotton from Egypt.
14. Using inside information, a political leader makes big profits selling stocks.
15. Ford purchases millions of tires for assembly lines of new cars.
16. You buy a car tire off the showroom floor of a tire and battery store.
17. You earn over $1 million in sales of Bitcoins.
18. You spend $2000 of stimulus money from Congress on food.
19. You are a manufacturer and you pay millions for plastic parts each year.
20. A company pays millions each year to keep old equipment running at the
factory.

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Circular Flow and GDP: Don't Count Items That Would Inflate The Value of The Economy, or "Double Count"

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Circular Flow and GDP

Circular Flow Model

Here are the basic premise points:

GDP versus GNP

C + Ig + G + Xn (Xn is also listed as X-IM in some texts)

6. You purchase an expensive 19th Century painting as an investment.

7. The federal government buys concrete for highway construction.

13. A US t-shirt company buys all its cotton from Egypt.

17. You earn over $1 million in sales of Bitcoins.

18. You spend $2000 of stimulus money from Congress on food.

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