Gross Domestic Product (GDP)
The market value of all final goods and services produced in an economy over a period of time (usually a year), regardless of who owns the factors of production.
In turn, the GDP is:
- The measure of the final market value of the national output produced by an economy over a time period.
- Calculated through the expenditure approach.
As we saw in the previous section, the expenditure approach calculates the total spending on final goods and services produced in an economy over a time period.
Components of the national spending
The nation spending (and hence the GDP) is calculated by breaking it down into 4 different components:
- Consumer spending (C): all spending made by households on final goods and services during a particular time period.
- Investment (I): investments made:
- By firms on physical capital: money spent on assets used to produce goods and services (factories, machinery, offices...).
- By households and firms on new construction: new housing and other new construction assets.
- Government spending (G): spending made by governments on the economy (roads, hospitals, purchasing of factors of production...).
- Net exports (X-M): the market value of the exports (X) of an economy minus the market value of imports (M) into an economy.
- Exports refer to goods and services produced domestically, and so are included in the calculation of the national output (GDP).
- Imports represent domestic spending on goods and services produced in external economies, and so must be subtracted from expenditures to accurately measure domestic output.
Summing up the addition of each national expenditure component, GDP can be expressed as:
GDP = C + I + G + (X-M)Common Mistake
Transfers payments are not included in government spending
Transfers payments are redistributions of income carried out by governments. An example can be unemployment benefits:
- The government collects income from the working force through taxes (leakage).
- The government offers payments to individuals who are unemployed and actively seeking for work (injection).
Transfer payments don't contribute to the national output because they are not an output addition, but a redistribution.
Only money that directly contributes to the output of the economy is included.
ExampleCalculating GDP from sets of national income data, using the expenditure approach
Let’s calculate the GDP for a fictional country, Econland. The following data is known about Econland (in billions of dollars):
| Expenditure Component | Subcategory | Amount (in billions) |
|---|---|---|
| Consumer Spending (C) | Durable goods | 500 |
| Non-durable goods | 400 | |
| Services | 300 | |
| Investment (I) | Residential construction | 200 |
| Business capital expenditures | 150 | |
| Improvements in inventories | 50 | |
| Government Spending (G) | Infrastructure | 150 |
| Defense spending | 50 | |
| Education and healthcare | 100 | |
| Exports (X) | Manufactured goods | 100 |
| Agricultural products | 50 | |
| Services | 50 | |
| Imports (M) | Consumer goods | 80 |
| Raw materials | 50 | |
| Services | 20 |
We begin by using the expenditure approach formula:
GDP = C + I + G + ( X − M )
The, we substitute the values from the table:
GDP = (500 + 400 + 300) + (200 + 150 + 50) + (150 + 50 + 100) + [(100 + 50 + 50) − (80 + 50 + 20)]
Now, we operate:
GDP = 1,200 + 400 + 300 + 50 = 1,950 billions of dollars.
Why use the expenditure approach?
Utilising the expenditure approach allows economists to:
- Measure the contribution of each spending component ( C + I + G+ (X-M) ) to the GDP.
- Understand the amount input of each spending component to the economic activity.
