Lesson 5.1: Gross Domestic Product

Evaluating Economies

  • Countries can be evaluated based on their production of goods and services each year

    • Second quarter 2025 GDP results:

      • India: $4.25 trillion

      • China: $19.4 trillion

      • United States: $30.5 trillion

  • National Income and Product Accounts (National Accounts): Accounts thtat track the flows of money among different sectors of the economy

    • Calculated in the United States by the Bureau of Economic Analysis, part of the United States Department of Commerce

    • Visulaized with the circular-flow diagram

Circular Flow

  • Households earn income from wages, interest, and profit in the factor market

  • Firms sell goods and services in the product market

  • Consumer spending produces a flow of goods and services to households and a return flow of money to firms

  • The government can act in both the product and factor market with taxes

    • Government transfers: Payments the government makes to individuals without expecting a good or service in return

Exports and Imports

  • The rest of the world participates in the model with exports, imports, and financial markets

    • Exports: Domestically-produced goods and services sold to other countries

    • Imports: Goods and services purchased from other countries

Gross Domestic Product

  • Defined as the dollar value of final goods and services produced within a country’s borders in a given year

    • Intermediate goods: Goods bought from one firm by another firm as inputs in the production of other final goods and services

      • Seen in the example of steel to automakers, becoming an intermediate good

    • Final goods: Goods sold directly to the end user

Inclusion in GDP

  • GDP doesn’t count:

    • Intermediate goods: Only final goods, not for resale in purchasing or manufacturing, are included in GDP

    • Second-hand goods: Spending on used goods is not counted as those were part of another year’s GDP

    • Black market goods: Illegal drugs, goods, or services are not part of GDP

    • Financial transactions: The purchase of financial assets like bonds and stocks are not producing a new good, they are simply moving wealth

    • Transfer payments: Payments from the government without obtaining a good or service in return are not counted

Calculation of GDP

Expidenture Approach

  • Adds aggregate spending on all domestically produced final goods and services in the product market of the economy

    • Expressed as $$GDP=C+I+G+\left(X-M\right)$, where:

      • C is consumer spending (typically the greatest factor)

      • I is investment spending

      • G is government purchases

      • X is the total amount of exports in a country

      • M is the total amount of imports in a country

Income Approach

  • Adds all income earned by the factors of production in the factor market of the economy

  • Factor income: Income that includes wages, interest earned, rent paid, and profits on physical capital