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|Section 5: Calculation of Gross Domestic Product Using the Expenditure and Income Approaches, and Net Domestic Product|
|Macroeconomics - Unit 3|
The Two Approaches to Calculating GDP
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There are two ways to calculate GDP: the expenditure approach, and the income approach. Each method results, if done accurately, in the same GDP amount each year. The expenditure approach is based on what we spend on final goods and services. The income approach is based on how much money we earn through the various forms of income.
The Expenditure Approach to Calculating GDP
Goods and services are purchased by four different groups of buyers: consumers, businesses, state and local governments, and foreign countries. Therefore, GDP can be calculated by summing these four components:
Examples of Consumption expenditures include spending by households on final products, such as clothing, televisions, dishwashers, computers, education, banking services, Ipods, cars, and food.
Net Exports are exports (products foreign countries buy from us) minus imports (goods we buy from other countries). Since 1983, United States imports have exceeded exports. Thus, for United States GDP, Net Exports is a negative number (see also the table in Section 1 of this unit).
The Income Approach to Calculating GDP
The income approach adds these six categories to arrive at Gross Domestic Product:
Net Domestic Product is gross domestic production minus the value of depreciation. It measures total production of final products minus what we lose each year due to obsolescence or the wearing out of machines and buildings. Thus, it is a measure of the net addition to our country's wealth.
Similarly, net private domestic investment is gross private domestic investment minus depreciation. If a country produces more capital goods relative to ones that become obsolete or worn out, then it experiences an addition to its capital stock. If businesses produce exactly enough machinery to just replace the worn out or obsolete capital goods, then the country's capital stock stays the same. If the country wants to experience economic growth, it can do so by increasing its capital stock. In Unit 1 we discussed that one of two ways to shift the production possibilities curve out is to increase resources, such as capital goods (the other way is to advance technology). One way to encourage increases in capital goods is to encourage more savings in the economy. This frees up funds in the financial markets, which allows businesses to borrow funds for investments in capital goods, as well as investments in technology and research.
For a video explanation of how to calculate Gross Domestic Product using the income approach, please watch the following:
|Last Updated on Monday, 15 June 2015 12:32|