The gross domestic product commonly abbreviated as the GDP is an index of a country’s entire economic output. It is the total value of everything produced within the boundaries of a particular country irrespective of whether it is the production of the citizens or foreigners. The nominal GDP measures the size of the economy in current year prices while the real GDP measures the current output but adjusted to the prices of a predetermined base year (Rosoiu, 2015). The fact that the GDP is a substantial value, particularly in developed economies such as the USA, it is common for economists to discuss the growth rate of the GDP rather than focusing on the real values (Feldstein, 2017).
The GDP is measured by adding the spending on newly produced finished goods and services within a specified period, commonly one year. While they are multiple ways of calculating the GDP including the income and expenditure approaches, the expenditure approach is the most widely used and discussed by economists (Landefeld, Seskin, & Fraumeni, 2008). Under the expenditure approach, the four main components of the GDP are; private consumption expenditure, investment expenditure, government purchase of goods and serves and net exports.
Private consumption expenditure encompasses consumption spending by households. It measures the monetary value of goods and services that are purchased by households and non-profit institutions for current use within the period of account. The products and services are classified into consumer durables, semi-durables, non-durables, and services. An example is an individual purchasing a refrigerator, a laptop, groceries or merely paying for a haircut. Consumer spending affects our daily life because it is the part of the GDP where we contribute to every time an individual makes a purchase. Moreover, in developed economies, private consumption expenditure contributes to almost seventy percent of the total GDP and as such results in most employment which in turn determines personal income and subsequently consumer spending (Feldstein, 2017).
Another component of the GDP under the expenditure approach is investment expenditure. Investment describes the additions to the physical stock of capital during a period (Landefeld, Seskin, & Fraumeni, 2008). Therefore, gross private domestic investments indicate the aggregate value regarding the additions of physical stock of capital. The investment includes the construction of factories and additions to a firm’s inventories of goods and services. An example of investment expenditure is Starbucks opening a new location in New York. Investment expenditure directly affects us since when firms increase their spending on capital goods they create new employment opportunities. Moreover, an increase in investment spending illustrates that consumers have more places to make purchases as such facilitating consumer satisfaction through increasing choices. Furthermore, it is acknowledged that this component is financed by the deposits that consumers make to banks as savings.
Another component of the GDP under the expenditure approach is the government purchases of goods and services. It summarizes government spending on products and services. Government spending encompasses the purchase of goods, services or infrastructure. The transfer payments the government makes to households or firms are not included to avoid the aspect of double counting since these values are already accounted for in consumer and investment spending respectively (Rosoiu, 2015). An example of government spending is the government building a new university. Government spending has direct implications in our lives since it facilitates the provision of public goods and utilities. Government spending creates job opportunities. However, it necessitates funding, in that the more the government spends, the more it taxes and borrows. Undeniably, when taxes rise, personal income falls, and when the government borrows large sums of funds from the bond market, it is likely to increase interest rates (Feldstein, 2017).
The fourth component of the GDP under the expenditure approach is net exports. Net export is the difference between domestic spending on foreign goods, imports, and global spending on local goods exports. Therefore, net export is the difference between exports and imports of a country (Landefeld, Seskin, & Fraumeni, 2008). An example is a restaurant purchasing 50,000 dollars worth of wine from another state. Many jobs are directly or indirectly tied to imports and exports. Moreover, net exports increase diversity and facilitate better consumer choice when more imports are allowed into a particular country. Additionally, more imports often work to lower prices of goods.
Feldstein, M. (2017). Underestimating the real growth of the GDP, personal income and productivity. Journal of Economic Perspectives, 31(2), 145-164.
Landefeld, S. J., Seskin, E. P., & Fraumeni, B. M. (2008). Taking the pulse of the economy: Measuring GDP. Journal of Economic Perspectives, 22(2), 193-216.
Rosoiu, L. (2015). The impact of government revenues and expenditures on economic growth. Procedia Economics and Finance, 32, 526-533.