Last modified on 26 November 2009, at 21:06

Principles of Economics/GDP

GDP is Gross Domestic Product (distinct from GNP, which is Gross National Product). There are two ways of determining a nation's GDP.

You've probably heard this term on the news or read about it in the paper when the national or global economy is being discussed. GDP is defined as the value of all the final goods and services produced in a country during a given time period. Intermediate goods aren't counted because they would in effect cause double-counting to occur. GDP also refers to the income of the country as well. GDP also only refers to goods produced within a certain country. This means that if a firm is located in one country but manufactures goods in another, those goods are counted as part of the foreign country's GDP, not the firm's home country. For example, BMW is a German company but cars manufactured in the United States are counted as part of the United States GDP.

You can think of it another way, GDP is 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.

National Income Accounting ModelEdit

GDP < the sum of all income earned = :

  • Employee compensation
  • Corporate profits (this is income that accrues to public companies' shareholders)
  • Proprietors' income (this is income that accrues to private companies' owners)
  • Net interest
  • Rental income

This interpretation is missing two additional, non-income components that must also be added to find GDP:

  • Depreciation costs
  • Indirect (excise and sales) taxes and subsidies

National Expenditure Accounting ModelEdit

The gross domestic product or the GDP is a measure of the total productivity of a country. It is a quantifiable figure that tells how much better the country and its people are at that point of time. GDP is defined as the market value of all the total goods and services produced in the country for the given period of time.

GDP = :

  • Consumption (C)
  • Investment (I)
  • Government spending (G)
  • Exports (X)
  • Imports (M)

 \mathrm\ GDP = C + G + I + (X - M)

Consumption C 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 G is the sum of all the goods and services purchased by the government.

Investment I 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 X 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 M are just the opposite. These are goods and services produced by other countries but consumed by the domestic country.

Together  X - M = net exports . This is just a way of getting the net value of the goods traded between the domestic country and the rest of the world. Why do we add exports but subtract imports? Well, exports are added to the GDP because the domestic country receives payment for those goods produced and that is part of the value added to the economy by the domestic country. However we subtract imports, instead of just NOT counting imports, because the payment of these goods is taken away from the domestic country and added to the foreign country from which they came. You can think of subtracting imports as taking out the part of consumption where the good or service came from a foreign country.