How to Measure GDP?

GDP can be measured based upon what is demanded for consumption or based upon what is produced. 

Since every market transaction must have both a buyer and a seller, GDP must be the same whether measured by what is demanded or by what is produced.

GDP Measured by Components of Demand

Gross domestic product (GDP) can be measured using four main components of demand: 

• consumer spending (consumption), 
• business spending (investment), 
• government spending on goods and services, and 
• spending on net exports.

Based on these four components of demand, we can measure GDP as:

GDP = Consumption + Investment + Government + Trade balance 

GDP = C + I + G + (X – M)

Understanding how to measure GDP is important for analyzing connections in the macro economy and for thinking about macroeconomic policy tools.

Consumption expenditure by households is the largest component of GDP, accounting for about two-thirds of the GDP in any year. This tells us that consumers’ spending decisions are a major driver of the economy. 

Investment expenditure refers to purchases of physical plant and equipment, primarily by businesses. 

New technology or a new product can spur business investment, but then confidence can drop and business investment can pull back sharply.

Government expenditure in the United States is close to 20% of GDP, and includes spending by all three levels of government: federal, state, and local. The only part of government spending counted in demand is government purchases of goods or services produced in the economy. 

A significant portion of government budgets consists of transfer payments, like unemployment benefits, veteran’s benefits, and Social Security payments to retirees. The government excludes these payments from GDP because it does not receive a new good or service in return or exchange. Instead they are transfers of income from taxpayers to others. 

When thinking about the demand for domestically produced goods in a global economy, it is important to count spending on exports—domestically produced goods that a country sells abroad. Similarly, we must also subtract spending on imports—goods that a country produces in other countries that residents of this country purchase. The GDP net export component is equal to the dollar value of exports (X) minus the dollar value of imports (M), (X – M). We call the gap between exports and imports the trade balance. If a country’s exports are larger than its imports, then a country has a trade surplus. 

GDP Measured by What is Produced

Everything that we purchase somebody must first produce. What a country produces can be broken into five categories: 

• durable goods, 
• nondurable goods, 
• services, 
• structures, and 
• the change in inventories. 

Since every market transaction must have both a buyer and a seller, GDP must be the same whether measured by what is demanded or by what is produced. 

By far the largest part of GDP, however, is services. 

Measuring GDP as the National Income

GDP is a measure of what is produced in a nation. The primary way GDP is estimated is with the Expenditure Approach we discussed above, but there is another way. Everything a firm produces, when sold, becomes revenues to the firm. Businesses use revenues to pay their bills: Wages and salaries for labor, interest and dividends for capital, rent for land, profit to the entrepreneur, etc. So adding up all the income produced in a year provides a second way of measuring GDP. This is why the terms GDP and national income are sometimes used interchangeably. The total. value of a nation’s output is equal to the total value of a nation’s income.

Related Topics

• Macroeconomics
• Macroeconomic Frameworks
• Macroeconomic Policy Tools
• Productivity Economics
• One-Third Rule
• Gross Domestic Product (GDP)
• Durable and Non-Durable Goods
• Weightless Economy
• Intermediate and Final Goods or Services
• Nominal GDP
• Converting Nominal to Real GDP
• GDP Inflator
• Nominal GDP Price Index
• Measuring GDP
  
• Gross National Product
• Net National Product
• Factor Income
• Gross National Income
• Expenditure Method
• The Problem of Double Counting GDP
• Double Counting
• Why is Tracking Real GDP Important? 
• Convert Currencies with Exchange Rates
• Convert GDP to a Common Currency
• Per Capita GDP
• GDP Per Capita
• GDP as a Measure of Society Well-Being
• Limitations of GDP as a Measure of the Standard of Living