What GDP counts
What gross domestic product measures, why income equals spending, and the four parts of spending that make up GDP.
FinanceEveryday economicsAbout 6 min: 3 reading, 3 practiceUpdated
General education, not financial advice.
- State the definition of GDP and explain each part
- Explain why an economy's income equals its expenditure
- Split GDP into consumption, investment, government purchases and net exports
Builds toward: Run your own money. Budget so there's room to save, spot and clear costly debt, compare savings and loan offers, and see what interest and inflation do to your money.
Everyday economics: news, prices and choices: lesson 8 of 11
- Everyday economics
- Trade-offs and opportunity cost 5 min
- Thinking at the margin and incentives 5 min
- Models and the circular flow 5 min
- Positive and normative statements 6 min
- Demand and what shifts it 5 min
- Supply, equilibrium and shifts 6 min
- What money is 5 min
- What GDP counts 6 min
- Real and nominal GDP 5 min
- Measuring unemployment 5 min
- The costs of inflation 6 min
Try first
You haven't learned this yet, so guess. Guessing before you read helps the explanation stick. Nothing here is scored.
Already know this? Take a 3-question check and skip ahead.
Get all three right and the lesson is marked done.
Pairs with any introductory economics textbook; for example N. Gregory Mankiw, Principles of Macroeconomics (6th ed.), chapter 10
What it is
Gross domestic product (GDP) is the market value of all final goods and services produced within a country in a given period of time. Mankiw takes the definition phrase by phrase:
- Market value: different goods are added up using their market prices.
- Of all: it tries to include everything sold legally in markets, including an estimate of the rent homeowners would pay themselves (imputed rent). It leaves out most illegal goods and most things made and used at home: vegetables bought in a shop count, vegetables grown in your garden don't.
- Final: only goods sold to their final users. Intermediate goods, such as the paper used to make a greeting card, are already included in the final price, so counting them too would double-count. (Intermediate goods added to a firm's inventory are counted as investment.)
- Goods and services: haircuts and healthcare count as well as cars.
- Produced: only things made in the period. A secondhand car sale is not counted; the car was counted when new.
- Within a country: it covers production inside the borders, whoever does it.
- In a given period: usually a year or a quarter.
Income equals expenditure. Every transaction has a buyer and a seller, so every dollar spent is a dollar of someone's income. GDP measures both the economy's total income and its total spending on output, which is why the circular-flow diagram balances.
Quick check
Tap an answer to check it.
A baker buys flour for 200 and sells bread for 500. How much do these sales add to GDP?
- That counts the flour twice
- GDP counts the final good's full value, not the baker's margin
Show answer
500: the flour is an intermediate good, already in the bread's price. GDP counts only final goods.
Why it matters
GDP is split into four kinds of spending:
Y = C + I + G + NX
- Consumption (C): households' spending on goods and services, except new housing.
- Investment (I): spending on capital equipment, inventories and structures, including households' purchases of new housing. (In everyday speech "investment" can mean buying shares; in GDP it means buying goods used to produce more goods.)
- Government purchases (G): spending on goods and services by all levels of government, including public workers' salaries. Transfer payments, such as pensions or unemployment benefit, are not included: they are not paid for any goods or services produced.
- Net exports (NX): exports minus imports. Imports are subtracted because they are already counted in C, I or G; a car bought from abroad raises consumption but is not produced at home.
Mankiw's figures (US, 2009): GDP was over 14 trillion dollars, or 46,372 dollars per person. Consumption was 71% of GDP. Per person: consumption 32,823, investment 5,278, government purchases 9,540, net exports −1,269 (negative because Americans bought more from abroad than they sold).
Other measures. Gross national product (GNP) counts the income of a country's permanent residents wherever they earn it, rather than all production inside the country.
Text description
Bar chart. Consumption: 32,823; Government purchases: 9,540; Investment: 5,278.
Worked example
A small economy in one year (figures made up, in millions):
| Spending | Amount |
|---|---|
| Household spending on goods and services | 600 |
| New homes bought by households | 50 |
| Firms' new machines and buildings | 120 |
| Government purchases | 200 |
| Government pensions and benefits | 90 |
| Exports | 150 |
| Imports | 170 |
- C = 600.
- I = 120 + 50 = 170 (new homes are investment).
- G = 200 (pensions are transfers, so they are left out).
- NX = 150 − 170 = −20.
- GDP = 600 + 170 + 200 − 20 = 950.
Common mistake
Adding transfer payments or imports into GDP. Pensions and benefits move income between people without paying for new output; imports are produced abroad. Both are left out (imports are subtracted to cancel their appearance in C, I or G).
Key terms
- gross domestic product (GDP)
- the market value of all final goods and services produced within a country in a given period
- consumption
- household spending on goods and services, except new housing
- investment
- spending on capital equipment, inventories and structures, including new housing
- government purchases
- spending on goods and services by all levels of government
- transfer payment
- a government payment not made in exchange for a good or service
- net exports
- exports minus imports
- intermediate good
- a good used up in producing another good
- gross national product (GNP)
- the total income earned by a country's permanent residents
Practise the key terms
Tap a card to turn it over. 8 cards.
| Front | Back |
|---|---|
| gross domestic product (GDP) | the market value of all final goods and services produced within a country in a given period |
| consumption | household spending on goods and services, except new housing |
| investment | spending on capital equipment, inventories and structures, including new housing |
| government purchases | spending on goods and services by all levels of government |
| transfer payment | a government payment not made in exchange for a good or service |
| net exports | exports minus imports |
| intermediate good | a good used up in producing another good |
| gross national product (GNP) | the total income earned by a country's permanent residents |
Practice
Work it through
Consumption 800, investment 250, government purchases 300, exports 120, imports 150, and transfer payments 100.
- 120 − 150
- 800 + 250 + 300 − 30; transfers are left out
- 800 ÷ 1,320 × 100
Sort it
Which group does this belong to?
A new car bought this year
A final good produced this yearShow answer
Counted in GDP. A final good produced this year
A secondhand car bought this year
It was counted when newShow answer
Not counted. It was counted when new
Vegetables grown in your own garden
Home production is left outShow answer
Not counted. Home production is left out
A haircut
A final serviceShow answer
Counted in GDP. A final service
A state pension payment
A transfer, not payment for outputShow answer
Not counted. A transfer, not payment for output
A family's purchase of a newly built house
Counted as investmentShow answer
Counted in GDP. Counted as investment
Quick quiz
Tap an answer to check it.
Why are imports subtracted in Y = C + I + G + NX?
- The subtraction is accounting, not a judgement
Show answer
They are already counted in C, I or G but were not produced at home. Subtracting them leaves only domestic production.
Why does GDP measure both income and spending?
- It follows from how transactions work
Show answer
Every transaction has a buyer and a seller: one's spending is another's income. Income and expenditure are two sides of the same transactions.
In short
- GDP: the market value of all final goods and services produced within a country in a period.
- It measures both total income and total spending.
- Y = C + I + G + NX; new housing is investment; transfers are left out.
- Mankiw's US 2009 figures: GDP over 14 trillion dollars, 46,372 per person.
Mastery check
Answer without looking back. Score 80% or more and the lesson is marked done. Your result is kept only in this browser.
Check yourself
Answer in your head first, then open the answer. Nothing is saved.
Is a household's purchase of a new house consumption or investment?
Show answer
Investment.
Why aren't intermediate goods counted separately in GDP?
Show answer
Their value is already included in the price of the final goods; counting them would double-count.
What were US net exports per person in 2009, according to Mankiw?
Show answer
−1,269 dollars.
Further reading
- N. Gregory Mankiw, Principles of Macroeconomics, 6th ed. (South-Western Cengage, 2012), chapter 10.
- On this site: Models and the circular flow and Real and nominal GDP.
Finished? Mark it done to fill in your leaf on the Finance map.