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This compensation may impact how and where listings appear. Investopedia does not include all offers available in the marketplace. Also, it is important to note that goods such as hand-knit sweaters are not counted as part of GDP if they are gifted and not sold. Only expenditure based consumption is counted. Investment I includes, for instance, business investment in equipment, but does not include exchanges of existing assets. Examples include construction of a new mine, purchase of software, or purchase of machinery and equipment for a factory.
Spending by households not government on new houses is also included in Investment. This avoids double-counting: if one buys shares in a company, and the company uses the money received to buy plant, equipment, etc. To count it when one gives it to the company would be to count two times an amount that only corresponds to one group of products. Note that buying bonds or stocks is a swapping of deeds, a transfer of claims on future production, not directly an expenditure on products.
Government spending G is the sum of government expenditures on final goods and services. It includes salaries of public servants, purchase of weapons for the military, and any investment expenditure by a government.
It does not include any transfer payments, such as social security or unemployment benefits. Exports X represents gross exports. Imports M represents gross imports. Imports are subtracted since imported goods will be included in the terms G, I, or C, and must be deducted to avoid counting foreign supply as domestic.
Note that C, G, and I are expenditures on final goods and services; expenditures on intermediate goods and services do not count. By calculating the value of goods and services produced in a country, GDP provides a useful metric for understanding the economic momentum between the major factors of an economy: consumers, firms, and the government.
There are a few methods used for calculating GDP, the most commonly presented are the expenditure and the income approach. Both of these methods calculate GDP by evaluating the final stage of sales expenditure or income income.
The most well known approach to calculating GDP, the expenditures approach is characterized by the following formula:. The income approach adds up the factor incomes to the factors of production in the society. It can be expressed as:. This method consists of three stages:. The sum of net value added in various economic activities is known as GDP at factor cost. GDP at producer price theoretically should be equal to GDP calculated based on the expenditure approach.
However, discrepancies do arise because there are instances where the price that a consumer may pay for a good or service is not completely reflected in the amount received by the producer and the tax and subsidy adjustments mentioned above may not adequately adjust for the variation in payment and receipt.
The income approach evaluates GDP from the perspective of the final income to economic participants. Gross domestic product provides a measure of the productivity of an economy specific to the national borders of a country. It can be measured a few different ways and the most commonly used metric is the expenditure approach; however, the second most commonly used measure is the income approach.
The income approach unlike the expenditure approach, which sums the spending on final goods and services across economic agents consumers, businesses and the government , evaluates GDP from the perspective of the final income to economic participants.
GDP over time : GDP is measured over consecutive periods to enable policymakers and economic agents to evaluate the state of the economy to set expectations and make decisions.
This method measures GDP by adding incomes that firms pay households for factors of production they hire- wages for labor, interest for capital, rent for land, and profits for entrepreneurship. The U. Consumption, being a part of income, directly depends upon income itself. Thus, consumption C is a function f of income Y.
This is called autonomous consumption denoted by C. This may be represented by b i. Consumption function linear, i. Where C represents total consumption, C represents autonomous consumption i. Y stands for level of income.
Thus, we can show the interrelationship in this way. The concept of consumption function is further clarified with the help of following schedule and diagram. Such subsistence consumption is called autonomous consumption. That is why consumption curve starts from positive point C on Y-axis. In the above Fig. Remember, consumption expenditure is the function of income, i.
In other words, when income increases, consumption expenditure does not increase at the same rate as income. This is called Keynesian Psychological law of consumption. I make the distinction, just to clarify our model, between income and disposable income because all of the aggregate income in an economy does not end up in consumers' pockets.
Just for a simplification, you might say, "Yeah, some of it ends up in firms' pockets," but the firms, at the end of the day, are owned by individuals, so it can end up in individuals' or consumers' pockets. But some of it goes off to the government. When you think about income, and if you spend any time looking at your pay stub this will become familiar to you, you have your income but you don't end up with all of that in your checking account or your pocket or your savings account.
A good fraction of that is taken out for taxes. What you have left over when you subtract taxes out of income, that is your disposable income. That's why I write this here because that's actually a more reasonable thing to say. They obviously can't spend a fraction of stuff that they don't have, the stuff that's taken out for taxes.
Just to visualize this, we can draw it. This will be a line. This might ring a bell from your early algebra days. Just the variables are different. Instead of a y, we have a c, but that's still the dependent variable. It's a function of disposable income. In algebra you'll often call this the independent variable. The most typical variable is x. It's really the same idea over here.
Let me draw this a little bit neater. We can graph this, what's essentially going to be a line. It doesn't have to be a line. We just constructed a consumption function that happens to be a line. This is consumption right over here in the vertical axis.
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