Macroeconomics: Gross Domestic Product (GDP)

As we previously saw, the circular flow model shows that all the spending in an economy will roughly equal all of the income received.

• Every dollar spent on goods or services is money earned by either firms or household. Thus, a nation's total expenditure is equal to the nation's total income.

• Everything bought was at some point was produced, a nation's (domestic) output is equal to national (domestic) income.

There are three methods for measuring a nation's total output:

• Expenditure approach

• Income approach

• Output approach

Expenditure approach for estimating GDP:

• Summing the spending on final new goods and services in a given year.

• Final goods are ready for consumption. Goods used as input in order to produce another goods are not included (only the final product/good is).

There are four types of spending in a nation's output:

• Consumption(C): spending made by domestic households on durable and non-durable goods and services in a given time.

• Investment(I): spending by firms on capital equipment and by households on newly constructed homes.

• Government spending(G): the government's expenditure on goods, services, and capital. Transfer payments are not included.

•  Net exports(Xn=X-M): total income earned by the sales of exports minus total amount spent by domestic households and firms on imported goods and services.

   

Income approach for estimating GDP:

Estimates GDP by summing the income of households in the resource (factor) market. Remember that national output equals national income.

• Wages: the payment households receive for providing labor, this also includes salary.

• Interests: the payment for the use of capital by firms. Most of capital spending is paid for with money borrowed from banks. The money in banks is in part derived from household's savings.

• Rent: the payment households receive in exchange for the use of their land.

• Profit: residuals after a firm deducts its costs of production from its revenue. In our case, revenue can be defined as price  times output.

Output approach for estimating GDP:

The output approach sums the total value of all final goods and services produced by a country in a year.

• This method sums the value of total output for various industries/ economic sectors.  One can find the value of total output by summing the output value for each sector of a nation's economy. This gives us the gross national product (GDP).

Notice that all three methods achieve the same result: GDP=national expenditure= national income. Furthermore, notice that for each method, imports (or foreign produced goods and services) are excluded from our calculation. For more information about this aspect I would suggest reading this article by Steven M. Suranovic.

Reference: Welker, Jason. AP Maroeconomics Crash Course. Research & Education Association (2014). p 64-69.