THE ECONOMY’S INCOME AND EXPENDITURE
If you were to judge how a person is doing economically, you might first look at his or her income. A person with a high income can more easily afford life’s necessities and luxuries. It is no surprise that people with higher incomes enjoy higher standards of living-better housing, better healthcare, fancier cars, more.opulent vacations, and so on The same logic applies to a nation’s overall economy. When judging whether the economy IS doing well or poorly, it is natural total the total income that everyone in the economy IS earning. That is the task of gross domestic product (GDP). GDP measures two things at once: the total income of everyone in the economy and the total expenditure on the economy’s output of goods and services. The reason that GOP can perform the trick of measuring both total in and total expenditure IS that these two things are really the same. For and economy as a whole. income must equal expenditure. Why is this true? An economy’s income is the same as Its because every transaction has two parties: a buyer and a seller. Every dollar of spending by some buyer is of income for some seller. Suppose, for instance, that Karen pays Doug $100 to mow her lawn. In this Doug is a seller of a service, and Karen is a buyer. Doug earns $100, and Karen spends the transaction contributes equally to the economy’s income and to its expenditure. GO measured as total in me or total expenditure, rises by $100 , Another way to see the equality of income and expenditure is With the diagram in Figure 1. As you may recall from Chapter 2, this diagram describes all the transactions households and firms in a simple economy.flt simplifies matters by assuming that all goods and services are bought by households and that households spend all of their income. In this economy, when house buy goods and services from firms, these expenditures flow through the markets for goods and services. When the firms in turn use the they receive from sales to pay workers’ wages, landowners’ rent, and firm owners’ profit, this income flows through the markets for the factors of production. Money continuously flows from house holds to firms and then back to households. GDP measures this flow of money. We can compute It for this economy in one of two ways by adding up the total expenditure by households or by adding up the total income (wages, rent, and profit) paid by firms. Because all expenditure in the economy ends up as someone’s income, GDP is the same regardless of we compute it) The actual economy is, of course, more complicated than the one illustrated in Figure 1. Households do not spend all of their income; they pay some of it to the government in taxes, and they save some for use in the future. In addition, households do not buy all goods and services produced in the economy me goods and services are bought by governments, and some are bought by firms that plan to use them in the future to produce their- own output. Yet regardless of whether a household, government, or firm buys a good or service, the transaction has a buyer and Thus, for the economy as a whole, expenditure and are always the same.
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