Thursday, August 21, 2008

The Composition of GDP

A Closer Look at the Measurement of Economic Growth

The Composition of GDP

Gross domestic product can be broken down into several categories based on the type of goods and services produced. For example, the output of the country can be divided into durable goods, non-durable goods, services, and structures.

GDP = durable goods + non-durable goods + services + structures

Durable goods are products that are used over a long period of time. Refrigerators, washing machines, and cars are examples of durable goods. Non-durable goods are products that are consumed over a short period of time. Food and clothing are examples of non-durable goods. Services are products that typically do not create a tangible commodity. Banking services, haircuts, and entertainment are examples of services. Structures are buildings. Over half of U.S. GDP is services.

Durable goods orders are sometimes used as an indicator of the health of the U.S. economy.

Gross domestic product also can be broken down into several categories based on the purchaser of the newly produced goods and services. This alternative way to divide GDP involves separating it into consumption spending, investment spending, government purchases, exports, and imports.

Source: The U.S. Economy: You Are Here

An equation that illustrates this relationship is:

GDP = C + I + G + X - M
where:
C = consumption spending
I = investment spending
G = government purchases
X = exports
M = imports

Consumption is the purchase of final goods and services by households. Investment is the purchase of capital equipment, inventories, and structures. Most of this is done by businesses. The purchase of a home by a household, however, is also considered to be investment.
Government purchases are payments made in exchange for currently produced goods and services. This includes salaries of current government workers, vehicles purchased for government use, and supplies for government offices. Government purchases do not include transfer payments. A transfer payment is a government payment not made in exchange for a good or service. Social Security benefits, retirement checks paid to former government employees, and welfare benefits are examples of transfer payments. Exports are goods and services sold by domestic producers to foreign purchasers. For example, a jet fighter manufactured in the U.S. and purchased by the government of Egypt is an exported good. Imports are goods and services sold by foreign producers to domestic purchasers. The domestic purchasers might by households, businesses, or the government. For example, a Mercedes-Benz automobile manufactured in Germany and sold to an American consumer is an imported good.

The difference between exports and imports (X – M) is referred to as net exports (NE). Thus an alternative way to write the equation for gross domestic product is:

GDP = C + I + G + NE

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