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Gross domestic product (GDP) is the total market value of all final goods and
services produced annually within a country's borders.

When GDP is initially calculated it is in current dollars. The value of final goods
and services evaluated at current-year prices is called nominal GDP.

In order to compare the current time period with past time periods we need to
compute GDP in constant dollars. That is we need to adjust GDP for inflation.
The value of final goods and services evaluated at base year-prices is called real
GDP.

For example, if real GDP decreases in at least two consecutive quarters the nation
is officially in a recession.

GDP is a measure of Production. If an economy produces only 10 units of output is
sold in the market at $4 per unit, then GDP equals $40. This also means that the
nations income will be $40 since for every dollar of output produced there is a
dollar of income earned.

Per Capita GDP is used as a measure of the average standard of living for each
nation.

If the nation had a population of only 20 people and its GDP was $40 then the per
capita GDP would be $40/20 = $2

Gross domestic product (GDP) is the total market value of all final goods and
services produced annually within a country's borders.

GDP only measures final goods which are goods sold to their ultimate users.
Intermediate goods (i.e., goods that are an input in the production of other goods)
are excluded in order to avoid double counting.

(1) (2) (3) (4)
Stage Value Cost of
Of of Intermediate Value
Production Sales Goods Added
Farm $200 0 by assumption $200
Flour Mill $400 $200 $200
Bakery $550 $400 $150
Retail Store $650 $550 $100
Total new production = Total Value Added = $650
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The total amount of new production is equal to the total value added at each
stage of production.
Value added is the market value that a firm adds to a product.
Because our new production or value added at the farm = $200 there has be a total
of $200 of income going to all of the owners and workers at the farm. I.e. output =
income

Value added is found by taking the difference between the value of sales and the
cost of the intermediate goods.

The total value added is thus equal to the contribution to GDP. In addition it is
equal to the earned income of everyone involved at the farm, flour mill bakery and
retail store.

This income may be earned in the form of wages, salaries or profits.


This income may be earned in the form of wages, salaries or profits.

(1) (2) (3) (4)
Cost
Stage Value of
Of of Intermediate Value
Production Sales Goods Added
Farm $200 0 by assumption $200
Flour Mill $400 $200 $200
Bakery $550 $400 $150
Retail Store $650 $550 $100
Total Value Added = of column (4) = $650

Note also in the definition of GDP that only the value of final goods and services
are included.





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Gross domestic product (GDP) is the total market value of all final goods and
services produced annually within a country's borders.

Some items are excluded from GDP for various reasons. This includes some items
that actually involve new production and others items that involve only monetary
exchange without new production.
There are 5 different categories of items excluded from GDP.
1. Underground Activities
2. Resale of Used Goods
3. Pure Financial Transactions
4. Government and Private Transfer Payments
5. Goods and Services Produced at Home and Consumed at Home

1. Underground Activities (the underground economy); illegal and legal
Illegal transactions are not counted in GDP, because there is no record of them.
Similarly, cash-only transactions, the bread-and-butter of the underground
economy, are not recorded; although the government tries to estimate their value,
they are not accurately counted in GDP.
2. Sales of Used Goods - GDP measures only current output.

3. Financial Transactions - These are transactions that involve trading existing
assets, such as stock purchases.
Pure financial transactions are not included in GDP because they involve no new
production. This is true even if there is a capital gain involved. Only the ownership
of the assets changes ownership.

Example: If you purchase $10 million worth of Ford stock there is no production
resulting from this at Ford. There is no income earned by workers or management
at Ford. The only new productive activity (which is listed separately) is the value
of the stock brokers services which might be as little as $30. If you sell the stock
for $17 million a week later there still is no new production taking place and thus
no addition to GDP other than the $30 brokers fee.

4. Government Transfer Payments and Private Transfer Payments
A transfer payment is a payment to a person that is not made in return for goods
and services currently supplied. These include unemployment checks, Social
Security benefits and veterans' benefits. These are not included to avoid double
counting.

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5. Goods and services produced at home and consumed at home. This would
include the value of your services if you painted your own house or apartment,
repaired your own plumbing, washed your car yourself, etc.

Gross domestic product (GDP) is the total market value of all final goods and
services produced annually within a country's borders.

GDP is measured by government in two different ways: the expenditure approach
and the income approach.

A third way of determining GDP would be to use the total value added at
every stage of production.

A. The Expenditure Approach-The economy is divided into four sectors:
The household sector, business sector, government sector, and foreign sector. GDP
= total spending by all 4 sectors of the nation.
The four sectors of the nation are:
1. The Household Sector
2. The Business Sector
3. The Government Sector
4. The Foreign Sector

The Household Sector
Consumption expenditures are the expenditures of the household sector are
called consumption. Consumption (C) includes spending on (1) durable goods
which last for more than one year, (2) non-durable goods, and (3) services.

2. The Business Sector
Gross Private Domestic Investment I or simply investment expenditures (I) is
the sum of certain expenditures by business, including (1) purchases of new capital
goods, (2) construction including new residential housing. The sum of (1) and (2)
is called fixed investment, so investment = fixed + inventory investment, (3)
changes in business inventories (inventory investment).

3. The Government Sector -
Government purchases (G) include government consumption expenditures such as
paper and pens and government investment expenditures, such as school desks, M-
1 tanks, bridges, and paper clips, to name a few. The salary of a U.S. Senator is
included here as the government purchase of a service. Government transfer
payments are not included to avoid double counting.
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4. The Foreign Sector -
Net Exports NX consists of imported goods (M) and services which are produced
abroad and purchased and consumed in the U.S., and exports (X). Domestic
business firms export some of their products to foreign economies. The difference
between the two is net exports NX and is the foreign sector in GDP. NX =X-
M.

The Expenditure Approach: GDP
= total spending by all 4 sectors of the nation.
The four sectors of the nation are:
1. The Household Sector
2. The Business Sector
3. The Government Sector
4. The Foreign Sector
Computing GDP-All final goods and services produced in the economy are bought
by someone. Therefore, by summing the value of those expenditures, we may
calculate the value of GDP. So, according to the expenditure approach: GDP = C
+ I + G + NX
Note: NX = net exports = Exports minus Imports

Expenditure Components of U.S. GDP for 2010 (billions of dollars)
Consumption 10,350.6
Durable goods 1,089.3
Nondurable goods 2,337.4
Services 6,923.9
Investment 1,822.5
Business fixed investment 1,413.2
Residential Investment 340.4
Inventory investment 68.9
Government Purchases 3,003.3
Net Exports -515.7
Exports 1,838.5
Imports 2,354.1

GDP = C + I + G + NX = $14,660.7 billion

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The GDP in the U.S. is about $14.6 trillion with the single largest component being
household consumption expenditures which are just over $10 trillion.


Once again we need to be aware of the difference between nominal and real GDP.
Suppose the nation produced only three different items in 2010 as described in the
table below.

2010 output Quantity Price P
2010
Q
2010

Bicycles 10 $100 $1,000
Sandwiches 90 5 450
Doctor visits 15 100 1,500
Nominal GDP 2010 = P
2010
Q
2010
= 2,950

Now suppose the follows represents 2011
2011 output Quantity Price P
2011
Q
2011

Bicycles 12 $100 $1,200
Sandwiches 95 6 570
Doctor visits 15 120 1,800
Nominal GDP 2011 = P
2011
Q
2011
= 3,570

Notice that the price of some items increases and the price of others stays the same.
The same is true for the quantity consumed. The nominal GDP has increased but
what about real GDP? To answer this question we need to find 2011 GDP in
constant 2010 prices. This means the base year is 2010 in this case.

Real GDP 2011 in constant 2010 prices = P
2010
Q
2011


2011 output Quantity
2011
Price
2010
P
2010
Q
2011

Bicycles 12 $100 $1,200
Sandwiches 95 5 475
Doctor visits 15 100 1,500
Real GDP 2011 = P
2010
Q
2011
= 3,175

Thus in real 2010 prices GDP increased from $2,950 to 3,175 or by 7.6%
[(3,175 2,950) 2,950] 100
= .0762 100 = 7.6%
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The nominal GDP for 2010 was $3,570 so a good portion of the increase we
initially saw in 2011 GDP was due to price increases.

Another interesting possibility would be as follows:
2010 output Quantity Price P
2010
Q
2010

Bicycles 10 $100 $1,000
Sandwiches 90 5 450
Doctor visits 15 100 1,500
Nominal GDP 2010 = P
2010
Q
2010
= 2,950

Now suppose the follows represents 2011
2011 output Quantity
2011
Price
2011
P
2011
Q
2011

Bicycles 8 $150 $1,200
Sandwiches 95 6 570
Doctor visits 15 120 1,800
Nominal GDP 2011 = P
2011
Q
2011
= 3,570

Calculating Real GDP 2011 in constant 2010 prices = P
2010
Q
2011

2011 output Quantity
2011
Price
2010
P
2010
Q
2011

Bicycles 8 $100 $ 800
Sandwiches 95 5 475
Doctor visits 15 100 1,500
Real GDP 2011 = P
2010
Q
2011
= 2,775


What we now see is that the 2011 nominal GDP has increased relative to 2010
however the real GDP of the nation in 2011decreased. This situation is not unique
to this hypothetical example. This occurred in the U.S. in 1990 1991.

GDP could also be found from the income side since for each dollar of output
produced a dollar of income is earned.
B. The Income Approach - All final goods and services are produced using
factors of production, land, labor, capital, and entrepreneurship. The resources or
factors of production are privately owned. These factors are paid for their efforts.
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By summing the value of those factor payments (i.e., income earned), we can
find the value of GDP. Domestic income is the total income earned by the people
and businesses within a country's borders.

Using the income approach GDP = the sum of the following sources of income:

Compensation of Employees (i.e. wages & salaries)
Rents
Interest
Proprietors Income
Corporate Profits
Taxes on Production and Imports

If GDP = $14.7 trillion using the expenditure approach then it should be = $14.7
using the income approach. Generally a slight statistical adjustment is needed.

GDP= total spending by all 4 sectors of the nation.
The four sectors of the nation are:
1. The Household Sector C Consumption
2. The Business Sector I Gross Investment
3. The Government Sector G Government Purchases
4. The Foreign Sector NX Net Exports

The nations output (i.e., GDP) = the nations income (i.e., Y) where Y is
then gross domestic income

GDP = Y
We need to remember however that GDP in reality is not actually exactly equal to
total income.

One reason why totaling expenditures to get GDP will not initially result in the
same dollar total coming from totaling all income is because some income
received, i.e., transfer payments, does not count in GDP to avoid double counting.
After making all of the necessary statistical adjustments then GDP will be exactly
equal to income.




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GDP = Y
We need to remember however that GDP in reality is not actually exactly equal to
total income. One reason why totaling expenditures to get GDP will not initially
result in the same dollar total coming from totaling all income is because some
income received, i.e., transfer payments, does not count in GDP to avoid double
counting. After making all of the necessary statistical adjustments then GDP will
be exactly equal to income.

GDP = C + I + G + NX
or
Y = C + I + G +NX


Nations income = Nations output
= GDP
GDP = Nations Total Expenditures

The third method that could be used for calculating GDP is:

C. The Value Added Approach
We saw earlier in our wheat farm example that GDP could also be found by
totaling the value added at every stage of production. This approach is not
generally used because it is far more complicated than the expenditure approach.


Using the expenditure approach

GDP = C + I + G + NX


GDP depreciation = Net Domestic Product abbreviated NDP
Note: Depreciation is also called the capital consumption allowance.
Depreciation is the difference between gross Investment spending I
g
and net
investment spending. It accounts for the normal wear and tear on capital goods.
The government allows business firms to deduct an amount for depreciation of
capital.

NDP (i.e., minus) payment of income earned for foreign owned resources
(people and capital) located in the U.S. + payment of income earned by U.S.
owned resources (people and capital) located abroad Indirect Business Taxes =
National Income (abbreviated NI)
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Payment of income earned by U.S. owned resources (people and capital) abroad)
minus payment of income earned for foreign owned resources (people and capital)
in the U.S is called net foreign factor income.

In other words NDP + net foreign factor income indirect business taxes = NI

This (i.e., net foreign factor income) is what creates the difference between Gross
Domestic Product (GDP) and Gross National Product (GNP). The latter measure
does not include this adjustment and therefore does not truly reflect the production
and income available to the people in the U.S. For example the profits earned by
foreign owned companies located in the U.S. flows back to the owner country and
therefore is never available to anyone here in the U.S. This is what makes GDP the
better measure.

National I ncome (NI) is the amount of earned income that is available to the
owners of the resources which is not the same as the amount received.

Another way of looking at NI is that it equals the total of:
Compensation of employees
Proprietors Income
Corporate Profits
Rental Income
Net Interest Net interest is the interest income received by U.S. households
and government minus the interest they paid out.


While National income is the amount of income available to the owners of
resources it is not the same as personal income.

National I ncome is the amount of earned income that is available to the owners
of the resources which is not the same as the amount received.

Income received is personal income. To obtain personal income from national
income we subtract four categories of income that is earned but never received by
any households from national income and then add in one category of income
received by households that is not earned and thus not in national income.



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National Income (NI)
Taxes on production and imports
Social Security Contributions by business
Corporate Income (or profit) Taxes
Undistributed Corporate profits
+ Transfer Payments
= Personal Income (PI) This is the before tax income of households

Personal Income (PI) Personal Taxes = Disposable Income (DI)

Disposable income is what most people think of as their net income or after tax
income.

Disposable income (DI) is the net amount of income that households in the U.S.
receive each year. There are only two things we can do with our disposable
income. We can spend it or save it. Therefore DI = C + S

Note: we could also find GDP by working backwards from DI. For example
we would add Personal Taxes to DI to obtain PI and so forth. This is the
income approach for calculating GDP.

We saw earlier that we need to convert nominal GDP into constant dollars or real
GDP in order to be able to compare GDP in different time periods. This is
accomplished by dividing nominal GDP by a price index called the GDP deflator.
Price indexes compare the total price of a market basket of goods and services in a
specific year to the price of the same market basket in a predetermined base year.