Understanding GDP Calculation Methods

Let's go ahead and calculate out GDP. Remember that there are two different ways of measuring GDP. We can take a look at the expenditure approach or the income approach based on the discussion that we had with the circular flow diagram. We do spend a little bit more time on the expenditure approach. This is the most preferred way that most economists do calculate GDP, but we can use the income approach as well to get the same exact answer. So in this video, we're going to be focusing on the expenditure approach, and in the next one, we're going to focus in on the income approach. With it. expenditure approach, we take a look at five different variables. We have Y equals C plus I plus G plus X minus M. Here, Y is going to be our measure of GDP. It also means income and economics. So anytime you see the variable Y in this instance, this is just going to be our measure of gross domestic product. C is going to be denoting our personal consumption expenditures. So exactly what do you and I buy on an everyday basis, also firms and corporations. I is going to be investment, gross private domestic investment, GPDI for a little bit of a shorthand right there. So what do firms and businesses, what do they invest in? What type of projects? G is going to be government spending. What does the government spend their money on? And X minus M is going to be our next net exports. X is our exports. M is our imports. So X, our exports, are things that we sell abroad. M is going to be our imports, what we buy from other countries. So our goal for this particular video is to go ahead and break down each one of these components of GDP just a little bit more and see exactly how it all comes together for our calculation of GDP. So first of all, we want to talk about consumption, personal consumption expenditures. It includes purchases of durable goods, non-durable goods, and services by consumers and businesses. And this is going to be the main driver of economic growth for the United States. Roughly about 70% of our GDP comes from these personal expenditures. Thank you. So let's go ahead and take a closer look at these three main categories of consumption. First, we have durable goods. We have durable goods. And like the name implies, durable goods are exactly that. They are durable. They have an average useful life of at least three years. Of at least three years. So we buy a particular item or good. and it lasts us at least three years, we consider this to be a durable good. So what are a few examples of durable goods? We can say maybe a car, a computer, maybe a phone. Hopefully you don't buy a new iPhone every single year. But these are big ticket items that we typically buy, and they should last us on average at least three years. We can say refrigerators, washing machines, dryers. This would all fit under the idea of these durable goods. Non-durable goods, on the other hand, Non-durable goods. These are all other goods that don't have an average useful life of at least three years. We can basically say that these are going to be all other tangible goods. So all other tangible goods. So here, these are things that we typically use right away, and we typically throw away on a fairly frequent basis. So they don't last us at least three years. So things like textiles, things like clothing. So clothes, a lot of clothes we typically throw out. Before the three years, we can say soap, a lot of food items as well. So here, all other tangible goods are going to fall under the non-durable goods category. And then finally here, the last component of consumption is going to be services. Services. So things that we use right away. So we cannot store them at the time of purchase. Cannot store at time of purchase. At time of purchase. So essentially, we use them right away. So things like... Going to a salon to get your hair cleaned, getting a haircut, going to maybe a car wash or a mechanic, getting some type of financial services. A lot of the U.S. economy is also based on these services. So here, this would all be considered under consumption as well. So durable goods, non-durable goods, and services, these three categories are all encapsulated under consumption. And like we said before, the consumption is roughly about 70%. of GDP. So consumption is roughly about 70% of GDP. So about 70% of the $21 to $22 trillion of GDP that the United States has is going to fall under these three categories right here. So we are a very, very big consumption-based economy. Next, the second variable is going to be investment. Gross private domestic investment, GPDI, includes a few things. Investment in structures, both residential and businesses. So if you want to go ahead, build up a new house. If you firm them businesses, they want to build up a new business as well. Any improvements to them as well would be falling under this category of investment. So Hard Rock Stadium, we... Management and team built up that stadium. They improved the stadium quite a lot in order to attract the recent Super Bowl that was here. That would be considered some type of investment and would fall under the investment category of the calculation of GDP. Equipment and software purchases. So once again, this is going to go into improving the productivity aspects of firms and corporations. So that would fall under investment as well. And changes in business inventory. This is probably going to be the weirdest one. out of these three that we see right here. It just tells us that this is business inventory that actually hasn't been sold just as of yet. So when businesses actually increase their business inventory, so when the change in business inventories is actually a positive number, they're just telling us that, yes, they are producing a lot of goods, but they just haven't sold it just as of yet. And because they haven't sold it, this is gonna be considered to be some type of investment. So these three things would be considered under the investment category. the calculation of GDP an investment it is a very big component of GDP as well but not as big as consumption so here in this case investment is about 15 to about 20 percent of GDP and this is the component that actually fluctuates the most depending on where we are in terms of the business cycle so when times are really really good we might be on the high side of this 20 percent But when times are very, very bad, when we're in some type of recession, it might go down to the lower end of these teens right here. So here, it really depends on what firms and corporations actually believe about the economy at any given moment. And this chart, this graph right here illustrates this fact. Anytime we have a recession, what do we notice about GPDI as a percentage of GDP? We see very steep drops in the percentage and the GPDI as a percentage of GDP. So here, essentially, when times are bad... investment goes down. But when times are really, really good, like they were in the past decade, we noticed that investment tends to creep up. Third component is going to be government spending. And government spending, as you can see right here, includes three components of the government, federal spending, state spending, and local spending. So here includes wages and purchases of goods and services from private businesses and purchases of new structures and equipment. And this is going to be done on the government level. So here, The main thing that we want to focus in on is that it includes all three levels of government. So federal level, the state level, and the local level, these are all included within the component of government spending. So in terms of the federal government, if they want to pursue some type of fiscal policy in order to stimulate the economy, that would be government spending on the federal level. For the state level, I am considered a state employee because I am employed by the university system, by the state's university system. So the $20 that they pay me every single day. would be seen as part of state government spending, but once again, part of government spending. And local government spending, so suppose that Miami-Dade, maybe Broward County, wants to improve the roadways within their counties, that would be seen as a local government purchase, but still under the big idea of government spending as well. And in terms of government spending, this one is actually fairly stable over time, but it's gonna depend on the type of government policies we have in place. So in terms of government spending, This is roughly about 20% of our GDP. And like I said before, it does depend on the type of administration that we have in power and the type of policies that they actually want to go ahead and pursue. So if we take a look over the years, depending on the type of administration and political parties that are in power, we do notice that this percentage is going to go up and down. So here, during what we have here, we have Reagan, we have Bush Sr. We have Clinton. So during Clinton's administration, we noticed that this percentage is going down. This is the first time that we ran a surplus in a very long while. He cut spending and also increased taxes. But we noticed a very sharp increase as we get into Bush Jr. and also Obama. So what did Bush Jr. do? This is exactly why we see increases here. We got into the war on terrorism with Barack Obama. This is exactly where we had the bailout and also with Obamacare, which is why we see very high increases in government spending. And also with our current administration with Donald Trump, we see decreases in his first two years. But we're going to see very big increases as we see with a lot more spending on the military, also in a lot of other areas, and also with a lot of spending in terms of stimulus in response to the COVID-19 type of pandemic. So here, this is exactly where we see government spending coming into play. Final two components, we tie them together, and this is going to be net exports. And net exports. exports equals exports minus imports and we do notice that because the United States is a very big consumer-based economy we don't have as much manufacturing as we did in the past we do notice that U.S. imports do exceed exports in many instances so net exports at least for the United States in this case is going to be a negative percentage of GDP. So let's go ahead and talk a little bit more about exports and imports. In terms of exports, exports right here Exports, we denote it as a shorthand with an X. And these are items that the United States sells overseas. So items, the U.S. sells overseas. O-ver-seas. Let me spell that correctly. O-ver-seas. So essentially, any goods that the United States sells to international countries or abroad is going to be considered to be some type of exports. So what type of goods and services do you think are going to be the biggest components of U.S. exports? We sell a lot of tech goods, so technology. We sell a lot of cars abroad. We sell a lot of agricultural products. Agri- cultural products. We also sell a lot of food, we can say as well, maybe drugs too. So here with exports, these are probably the main U.S. exports that we see right here. We do sell a lot of these goods abroad to foreign countries, and this would be considered to be our exports here in the U.S. On the other hand, we also import a lot of goods from other countries. So this is imports. This is going to be our M component. And imports are just items that the U.S. buys from other countries. items the US buys from other countries from other Countries so here in the United States like in many countries We can't produce every single good because that's not where our comparative advantage lies So we're just gonna go ahead and buy them off of other countries and what type of goods do we like to import? We'd like to import a lot of cars as well. We import oil Clothing so textiles textiles are gonna be a big component We can say a lot of food products as well, so things like bananas, avocados. We probably import a lot of drugs as well, so both legal and illegal. So you're going to notice that we do export and import a lot of the same products in terms of any one particular country. But essentially, these would be a few of the big imports that the U.S. buys from other countries. And of course, X minus M, this typically is a negative percentage in the United States because we do tend to import more. than we do export. This is roughly about negative 3% to 5% on any given year. So now that we have a better idea of the components of GDP, we have consumption, investment, government spending, imports, and exports, we can go ahead and see exactly how all of these are going to come into play into the calculation of GDP itself when we go ahead and take a look at this balance sheet right here. And we'll go a little bit more in depth into that into our next lecture video.

We do spend a little bit more time on the expenditure approach. This is the most preferred way that most economists do calculate GDP, but we can use the income approach as well to get the same exact answer. So in this video, we're going to be focusing on the expenditure approach, and in the next one, we're going to focus in on the income approach.

With it. expenditure approach, we take a look at five different variables. We have Y equals C plus I plus G plus X minus M. Here, Y is going to be our measure of GDP. It also means income and economics.

So anytime you see the variable Y in this instance, this is just going to be our measure of gross domestic product. C is going to be denoting our personal consumption expenditures. So exactly what do you and I buy on an everyday basis, also firms and corporations. I is going to be investment, gross private domestic investment, GPDI for a little bit of a shorthand right there. So what do firms and businesses, what do they invest in?

What type of projects? G is going to be government spending. What does the government spend their money on?

And X minus M is going to be our next net exports. X is our exports. M is our imports. So X, our exports, are things that we sell abroad.

M is going to be our imports, what we buy from other countries. So our goal for this particular video is to go ahead and break down each one of these components of GDP just a little bit more and see exactly how it all comes together for our calculation of GDP. So first of all, we want to talk about consumption, personal consumption expenditures. It includes purchases of durable goods, non-durable goods, and services by consumers and businesses. And this is going to be the main driver of economic growth for the United States.

Roughly about 70% of our GDP comes from these personal expenditures. Thank you. So let's go ahead and take a closer look at these three main categories of consumption.

First, we have durable goods. We have durable goods. And like the name implies, durable goods are exactly that.

They are durable. They have an average useful life of at least three years. Of at least three years.

So we buy a particular item or good. and it lasts us at least three years, we consider this to be a durable good. So what are a few examples of durable goods? We can say maybe a car, a computer, maybe a phone.

Hopefully you don't buy a new iPhone every single year. But these are big ticket items that we typically buy, and they should last us on average at least three years. We can say refrigerators, washing machines, dryers. This would all fit under the idea of these durable goods. Non-durable goods, on the other hand, Non-durable goods.

These are all other goods that don't have an average useful life of at least three years. We can basically say that these are going to be all other tangible goods. So all other tangible goods.

So here, these are things that we typically use right away, and we typically throw away on a fairly frequent basis. So they don't last us at least three years. So things like textiles, things like clothing. So clothes, a lot of clothes we typically throw out.

Before the three years, we can say soap, a lot of food items as well. So here, all other tangible goods are going to fall under the non-durable goods category. And then finally here, the last component of consumption is going to be services. Services.

So things that we use right away. So we cannot store them at the time of purchase. Cannot store at time of purchase.

At time of purchase. So essentially, we use them right away. So things like... Going to a salon to get your hair cleaned, getting a haircut, going to maybe a car wash or a mechanic, getting some type of financial services. A lot of the U.S. economy is also based on these services.

So here, this would all be considered under consumption as well. So durable goods, non-durable goods, and services, these three categories are all encapsulated under consumption. And like we said before, the consumption is roughly about 70%. of GDP.

So consumption is roughly about 70% of GDP. So about 70% of the $21 to $22 trillion of GDP that the United States has is going to fall under these three categories right here. So we are a very, very big consumption-based economy. Next, the second variable is going to be investment.

Gross private domestic investment, GPDI, includes a few things. Investment in structures, both residential and businesses. So if you want to go ahead, build up a new house.

If you firm them businesses, they want to build up a new business as well. Any improvements to them as well would be falling under this category of investment. So Hard Rock Stadium, we... Management and team built up that stadium. They improved the stadium quite a lot in order to attract the recent Super Bowl that was here.

That would be considered some type of investment and would fall under the investment category of the calculation of GDP. Equipment and software purchases. So once again, this is going to go into improving the productivity aspects of firms and corporations.

So that would fall under investment as well. And changes in business inventory. This is probably going to be the weirdest one. out of these three that we see right here. It just tells us that this is business inventory that actually hasn't been sold just as of yet.

So when businesses actually increase their business inventory, so when the change in business inventories is actually a positive number, they're just telling us that, yes, they are producing a lot of goods, but they just haven't sold it just as of yet. And because they haven't sold it, this is gonna be considered to be some type of investment. So these three things would be considered under the investment category. the calculation of GDP an investment it is a very big component of GDP as well but not as big as consumption so here in this case investment is about 15 to about 20 percent of GDP and this is the component that actually fluctuates the most depending on where we are in terms of the business cycle so when times are really really good we might be on the high side of this 20 percent But when times are very, very bad, when we're in some type of recession, it might go down to the lower end of these teens right here. So here, it really depends on what firms and corporations actually believe about the economy at any given moment.

And this chart, this graph right here illustrates this fact. Anytime we have a recession, what do we notice about GPDI as a percentage of GDP? We see very steep drops in the percentage and the GPDI as a percentage of GDP.

So here, essentially, when times are bad... investment goes down. But when times are really, really good, like they were in the past decade, we noticed that investment tends to creep up. Third component is going to be government spending. And government spending, as you can see right here, includes three components of the government, federal spending, state spending, and local spending.

So here includes wages and purchases of goods and services from private businesses and purchases of new structures and equipment. And this is going to be done on the government level. So here, The main thing that we want to focus in on is that it includes all three levels of government. So federal level, the state level, and the local level, these are all included within the component of government spending.

So in terms of the federal government, if they want to pursue some type of fiscal policy in order to stimulate the economy, that would be government spending on the federal level. For the state level, I am considered a state employee because I am employed by the university system, by the state's university system. So the $20 that they pay me every single day. would be seen as part of state government spending, but once again, part of government spending.

And local government spending, so suppose that Miami-Dade, maybe Broward County, wants to improve the roadways within their counties, that would be seen as a local government purchase, but still under the big idea of government spending as well. And in terms of government spending, this one is actually fairly stable over time, but it's gonna depend on the type of government policies we have in place. So in terms of government spending, This is roughly about 20% of our GDP. And like I said before, it does depend on the type of administration that we have in power and the type of policies that they actually want to go ahead and pursue.

So if we take a look over the years, depending on the type of administration and political parties that are in power, we do notice that this percentage is going to go up and down. So here, during what we have here, we have Reagan, we have Bush Sr. We have Clinton. So during Clinton's administration, we noticed that this percentage is going down.

This is the first time that we ran a surplus in a very long while. He cut spending and also increased taxes. But we noticed a very sharp increase as we get into Bush Jr. and also Obama. So what did Bush Jr. do?

This is exactly why we see increases here. We got into the war on terrorism with Barack Obama. This is exactly where we had the bailout and also with Obamacare, which is why we see very high increases in government spending. And also with our current administration with Donald Trump, we see decreases in his first two years. But we're going to see very big increases as we see with a lot more spending on the military, also in a lot of other areas, and also with a lot of spending in terms of stimulus in response to the COVID-19 type of pandemic.

So here, this is exactly where we see government spending coming into play. Final two components, we tie them together, and this is going to be net exports. And net exports.

exports equals exports minus imports and we do notice that because the United States is a very big consumer-based economy we don't have as much manufacturing as we did in the past we do notice that U.S. imports do exceed exports in many instances so net exports at least for the United States in this case is going to be a negative percentage of GDP. So let's go ahead and talk a little bit more about exports and imports. In terms of exports, exports right here Exports, we denote it as a shorthand with an X. And these are items that the United States sells overseas. So items, the U.S. sells overseas.

O-ver-seas. Let me spell that correctly. O-ver-seas.

So essentially, any goods that the United States sells to international countries or abroad is going to be considered to be some type of exports. So what type of goods and services do you think are going to be the biggest components of U.S. exports? We sell a lot of tech goods, so technology.

We sell a lot of cars abroad. We sell a lot of agricultural products. Agri- cultural products. We also sell a lot of food, we can say as well, maybe drugs too.

So here with exports, these are probably the main U.S. exports that we see right here. We do sell a lot of these goods abroad to foreign countries, and this would be considered to be our exports here in the U.S. On the other hand, we also import a lot of goods from other countries.

So this is imports. This is going to be our M component. And imports are just items that the U.S. buys from other countries. items the US buys from other countries from other Countries so here in the United States like in many countries We can't produce every single good because that's not where our comparative advantage lies So we're just gonna go ahead and buy them off of other countries and what type of goods do we like to import?

We'd like to import a lot of cars as well. We import oil Clothing so textiles textiles are gonna be a big component We can say a lot of food products as well, so things like bananas, avocados. We probably import a lot of drugs as well, so both legal and illegal. So you're going to notice that we do export and import a lot of the same products in terms of any one particular country. But essentially, these would be a few of the big imports that the U.S. buys from other countries.

And of course, X minus M, this typically is a negative percentage in the United States because we do tend to import more. than we do export. This is roughly about negative 3% to 5% on any given year. So now that we have a better idea of the components of GDP, we have consumption, investment, government spending, imports, and exports, we can go ahead and see exactly how all of these are going to come into play into the calculation of GDP itself when we go ahead and take a look at this balance sheet right here. And we'll go a little bit more in depth into that into our next lecture video.

Transcript for:Understanding GDP Calculation Methods

Transcript for:
Understanding GDP Calculation Methods