Methods of calculating national income - Expenditure Method

Correct answer: A. Purchase of previously issued shares

Explanation: Purchasing previously issued shares transfers ownership of an existing financial asset from one person to another. It does not represent a purchase of a good or service produced in the current year, so it is excluded from expenditure on current output. In contrast, a new machine is investment, government textbooks are government final consumption, and new furniture is household consumption.

Correct answer: B. A scholarship is a transfer payment, while a government education service may be part of GFCE

Explanation: A scholarship is a transfer payment because the recipient receives income without supplying a current good or service directly in return. It is therefore not counted as payment for current production. Government schools, however, produce education services; the government’s current spending on producing those services is included in government final consumption expenditure, or GFCE. Hence, option B is correct.

Correct answer: B. First in PFCE, second in GCF

Explanation: A household buying a car for personal use makes a final consumption purchase, so it is included in Private Final Consumption Expenditure (PFCE). A taxi company buys the car as a productive asset that will provide transport services over several years. Therefore, it is treated as capital formation, specifically Gross Capital Formation (GCF). The classification depends on the purpose and use of the vehicle, not merely on the physical identity of the car.

Correct answer: B. Commission paid to a broker on the sale of a used car

Explanation: The full selling price of a used car is not included in current GDP because the car was produced and counted in an earlier period. However, the broker performs a current-market service when arranging the sale, and the commission is payment for that current service. It is therefore included in GDP at market price. A pension is a transfer payment, and purchasing shares is a financial transaction; neither represents current production.

Correct answer: A. Because the goods have not yet reached the final user

Explanation: Goods purchased by a producer for resale are still moving through the production and distribution chain. They have not yet reached the person or organization that will use them for final consumption or investment. Counting their full value at the resale stage and again at final purchase would create double counting. Therefore, such goods are treated as intermediate or trading purchases until the final sale, when the value of the final product is recorded.

Correct answer: A. Export of services

Explanation: A domestic university provides an education service within the domestic territory. When foreign students pay for that service, the expenditure comes from the foreign sector while the service is produced domestically. In national accounting, this is treated as an export of services. It contributes to net exports because receipts for services supplied to foreigners are added, whereas payments for services supplied by foreign producers are treated as imports.

Correct answer: B. Import

Explanation: The university service is produced outside the domestic territory, even though the student who purchases it is an Indian resident. The payment is therefore expenditure on a foreign-produced service and is recorded as an import of services. In the expenditure identity, imports are subtracted from domestic expenditure because consumption or other spending may include foreign-produced goods and services. This subtraction ensures that GDP measures domestic production only.

Correct answer: A. Government final consumption expenditure

Explanation: Paper and stationery are routinely used as inputs in the day-to-day functioning of a government office and in the provision of public services. Their purchase does not create a durable asset such as a building, vehicle or machine, so it is not gross fixed capital formation. It is also neither an international transaction nor a financial investment. In the school-level expenditure classification, this regular current government spending is included in Government Final Consumption Expenditure.

Correct answer: A. Because PFCE may include expenditure on foreign goods and services

Explanation: PFCE is measured according to the spending of resident households, so it can include purchases of both domestically produced and imported goods and services. GDP, however, measures production within the domestic territory. Imports are therefore subtracted from total expenditure, usually through the net-export term, to remove the value of foreign production. This prevents imported consumption from being incorrectly counted as domestic output.

Correct answer: A. It is total final expenditure at market prices on final goods and services produced within domestic territory

Explanation: GDP at market prices measures the value of final goods and services produced within a country’s domestic territory, valued at the prices paid in the market. In the expenditure approach, it is represented by final consumption expenditure, investment expenditure, government final expenditure and net exports. Therefore, option A correctly combines the ideas of domestic production, final output and market valuation.

Correct answer: C. Purchase of company shares by a household

Explanation: The purchase of company shares is a financial transaction involving a change in ownership of a financial asset. It does not represent payment for a newly produced good or service in the current period, so it is excluded from final consumption expenditure and national income. A new car and medical services are consumption of final goods or services, while government-school services are treated as government final consumption.

Correct answer: A. The measurement of current real production becomes incorrect

Explanation: Financial transactions such as buying shares, bonds or other existing financial assets do not represent current production of goods and services. If these transactions are added to final expenditure, the expenditure total will contain payments unrelated to current output. This can overstate or otherwise distort the estimate of GDP and national income. Hence, option A is correct.

Correct answer: A. Because final expenditure reflects demand for domestic final output

Explanation: The expenditure method relies on the equivalence between the value of final output and expenditure on that final output. Households, firms, government and foreign buyers spend on final goods and services produced within the domestic territory. Adding their relevant final expenditures captures the demand-side value of domestic production, while imports are deducted to avoid counting foreign output. Therefore, option A is correct.

Correct answer: C. Domestic expenditure on finished consumer goods purchased from abroad

Explanation: GDP measures production within domestic territory, not production occurring abroad. Spending by domestic consumers on imported finished goods may initially appear in consumption expenditure, but the import component is subtracted in the expenditure identity: GDP = C + I + G + X − M. This removes the value of foreign production. Government final consumption, domestic investment and exports of domestic goods are included, so option C is correct.

Correct answer: A. The purchase appears in PFCE and is subtracted as imports

Explanation: A household’s purchase of a foreign mobile phone is recorded initially as private final consumption expenditure because the household has spent money on a final consumer good. However, the phone was produced abroad, so its value is included in imports and subtracted in the GDP expenditure identity. This prevents foreign production from being counted as domestic production. Therefore, option A is correct.

Correct answer: C. Gross domestic capital formation

Explanation: A newly produced machine purchased by a firm is a capital good because it is used in the production process and provides productive services over more than one period. Its purchase is therefore recorded as investment expenditure, specifically gross domestic capital formation. It is not household consumption, government consumption or an export merely because it is sold by a producer. Hence, option C is the correct classification.

Correct answer: A. Because the service is produced within domestic territory

Explanation: GDP follows the domestic-territory principle: it counts the value of goods and services produced within the territory, regardless of whether the producer is locally or foreign owned. Therefore, a banking service supplied by a foreign-owned bank from an establishment operating inside the country can contribute to domestic production and GDP. Nationality of ownership is not the deciding criterion for GDP.

Correct answer: A. Because the house provides housing services

Explanation: An owner-occupied house produces a housing service for its owner even though no rent is actually paid. National income accounting imputes, or estimates, the rent that would have been paid for a similar rented house. This estimated amount is treated as private final consumption expenditure so that owner-occupiers and tenants are treated consistently and the value of the housing service is included in GDP.

Correct answer: A. Purchase of a newly produced machine by a firm in the current year

Explanation: A newly produced machine purchased by a firm is a capital good produced during the current accounting period. Its purchase adds to the productive capital stock and is therefore included in gross investment, a component of GDP expenditure. Buying an old house or used machine generally transfers ownership of an existing asset, while buying a government bond is a financial transaction rather than current production.

Correct answer: A. Because it is not a new asset produced in the current year

Explanation: The purchase of an old building does not represent the production of a new building during the current accounting period. It normally changes the ownership of an already existing capital asset, so counting the full purchase price as new capital formation would duplicate an earlier production value. Government can undertake capital formation, but this particular transaction is not new current output.

Correct answer: C. Purchase of a new machine by a firm for production

Explanation: A newly produced machine bought by a firm for production is a current capital good and increases the economy’s productive asset base. It is therefore included in gross domestic capital formation, usually under gross fixed capital formation. Old shares are financial assets, pensions are transfer payments, and a used car is an existing asset whose sale does not represent current production.

Correct answer: B. Export of a service

Explanation: The museum is located domestically and provides a cultural service produced within the domestic economy. Although the buyer is a foreign tourist, the spending is made by a non-resident on domestic output. In national accounting, this is treated as an export of services and contributes to exports in the expenditure identity, rather than as an import or investment.

Correct answer: B. Gross investment

Explanation: When finished goods are produced but remain unsold, they have not been purchased by households, firms, or the government. Nevertheless, current production has occurred and the goods become part of the firm’s inventory. National accounting records the increase in inventories as inventory investment, which is included in gross investment in the expenditure approach. A decrease in inventories is recorded as negative inventory investment.

Correct answer: B. Depreciation is subtracted

Explanation: The word ‘gross’ includes depreciation, also called consumption of fixed capital. To convert a gross domestic product measure into its net counterpart while retaining the market-price basis, depreciation is subtracted: NDPMP = GDPMP − depreciation. Net indirect taxes are relevant when converting between market prices and factor cost, while NFIA converts domestic to national aggregates.

Correct answer: A. 3850

Explanation: The expenditure identity is GDPMP = PFCE + GFCE + GCF + NX. Substituting the values gives 2500 + 700 + 900 − 250 = 3850. Net exports are negative because imports exceed exports, so their magnitude must be subtracted from domestic expenditure. Hence option A, 3850, is correct; 4100 would incorrectly treat negative NX as positive.