Econ: Gross Domestic Product

GDP imageGross Domestic Product (GDP) is the primary measure of a nation’s macroeconomic performance, so it is important to understand how GDP is calculated and to address cautions in its use. GDP is the value of all final products produced in a country in one year. GDP focuses on production within the United States, regardless of where in the world the company’s headquarters are located, so Toyotas produced in the United States are counted in the GDP of the United States, not Japan. GDP does not include intermediate goods, purely financial transactions, secondhand sales, household production (cooking one’s own food, mowing one’s own yard), or illegal activity.

GDP can be calculated via two different approaches. The expenditure formula is: GDP = C + I + G + X. The consumer sector (C) represents purchases by households, representing about 70% of all consumption in the economy. The investment sector (I) includes business purchases of equipment, all construction, and inventories. Investment is particularly important because if investment is less than depreciation, capital stock will fall, hurting future economic growth. The government sector (G) includes government purchases and investment (as in libraries), but does not include transfer payments such as Social Security checks (because they will be counted when spent by households). Net exports (X) are calculated by the formula: Exports – Imports. Because the United   States imports significantly more than it exports, the foreign sector is a negative number. GDP can also be calculated from an income approach: GDP = Wages + Rents + Interest + Proprietors’ Income + Corporate Profits. If we had accurate numbers, GDP calculated from either approach would be equal, because one person’s spending is income to someone else.



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