MEP - Gross Domestic Product (Lesson)

Gross Domestic Product

Introduction

Fluctuations in output are measured by increases or decreases in the quantity of goods and services produced in the economy over time. The gross domestic product, or GDP, is commonly used to measure economic growth. The GDP is the dollar value of all final goods and services produced in the economy during a growth period.

Final goods are goods intended for consumers. For example, gasoline is a final good purchased by consumers but crude oil, used to make gasoline, is not.

Note that GDP does not count the purchase of second hand goods or stocks and bonds because these do not represent new production during the year. GDP also does not include items that are not exchanged in a legal market (e.g. mowing your own lawn, caring for your own children, or purchasing illegal goods).

 

What is GDP?

GDP is the value of all the final goods and services produced in a country during a given time period. Intermediate goods are not counted because they would cause double-counting to occur. GDP only refers to goods produced within a particular country. For instance, if a firm is located in one country but manufactures goods in another, those goods are counted as part of the manufacturing country's GDP, not the firm's home country. BMW is a German company, but cars manufactured in the U.S. are counted as part of the U.S. GDP. GDP is a measure used by economists to determine how productive a country is on the whole.

GDP per capita is often considered an indicator of a country's standard of living. Under economic theory, GDP per capita exactly equals the gross domestic income (GDI) per capita.

 

How Is GDP Determined?

GDP can be determined in three ways:

• the product (or output) approach;
• the income approach; and
• the expenditure approach.

For this lesson we will focus on the EXPENDITURE APPROACH.

The expenditure approach works on the principle that all products must be bought by a consumer; therefore, the value of the total product must be equal to consumers' total expenditures.

The expenditure approach only measures products that are intended to be sold. If you knit yourself a sweater, it is production but does not get counted as GDP because it is never sold. Components of GDP by expenditure are:

consumption + gross investment + government spending + (exports − imports)

Note: In the expenditure-method equation given above, the exports-minus-imports term is necessary in order to null out expenditures on things not produced in the country (imports) and add in things produced but not sold in the country (exports).

Consumption is normally the largest GDP component in the economy. Consumables fall under one of the following categories: durable goods, non-durable goods and services. Examples include food, rent, jewelry, gasoline and medical expenses.

Examples of investment include the construction of a new mine, purchase of software, or purchase of equipment for a factory. Spending by households on items like new houses is also included in investment. Buying financial products is classed as saving, as opposed to investment.

Government spending is the sum of government expenditures on final goods and services. It includes salaries of public servants, purchase of weapons for the military, and any investment expenditure by a government. It does not include any transfer payments like social security or unemployment benefits.

 

GDP and our Economy

The presentation below will cover GDP. 

 

Calculating GDP

You can think of GDP as a way for us to measure how productive a country is on the whole. Let's break down the name for concrete understanding. Gross refers to the summation of all the country's resources towards producing output. Domestic just relates the output to the country from which the output was produced. Lastly, product just refers to the goods and services that make up output.

GDP can be written algebraically as:

• Consumption is essentially the aggregate of all the goods and services consumed in the country. Haircuts, hamburgers, gasoline etc. are all part of the GDP in the country in which they are purchased.

• Government Spending is just what it sounds like, it is the sum of all the goods and services purchased by the government.
• Investment is a bit trickier because most people confuse this term with financial investment. In economics, we refer to investment as the purchase of new capital by firms or individual consumers. That is, firms can buy non-residential capital (buildings, equipment etc.) and individual consumers can purchase residential capital (i.e. houses). If we ever mean the kind of investment done through the stock market or finances, we will specifically use the term financial investment. So unless otherwise noted, investment will always mean capital investment.
• Exports are all the goods and services exported to foreign countries. That is, the goods and services produced by the domestic country and consumed by foreign countries.
• Imports are just the opposite. These are goods and services produced by other countries but consumed by the domestic country.

Watch the video below to learn more about calculating GDP.

 

 

Review

Review what you have learned by completing the activity below.

 

In Summary . . .

The size of a nation’s economy is commonly expressed as its gross domestic product (GDP), which measures the value of the output of all goods and services produced within the country in a year. GDP is measured by taking the quantities of all goods and services produced, multiplying them by their prices, and summing the total. Since GDP measures what is bought and sold in the economy, it can be measured either by the sum of what is purchased in the economy or what is produced. GDP can be divided into consumption, investment, government, exports, and imports. What is produced in the economy can be divided into durable goods, nondurable goods, services, structures, and inventories. To avoid double counting, GDP counts only final output of goods and services, not the production of intermediate goods or the value of labor in the chain of production.

 

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