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Gross Domestic Product (GDP) and Consumer Price Index (CPI)

Calculating GDP


Calculating GDP

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Alright, let's go through one of the more important calculations in this course, calculating gross domestic product. So we're gonna go through the formal definition of gross domestic product here? There's a few different ways to calculate it. A few different ways they talk about in this class, but this is the formal definition of it. So let's go ahead and go through it. So gross domestic product it's the value. So we're finding some sort of value of final goods and services produced. Okay, so final goods and services produced when we say final, that means they're going to the end user so things can be go through different stages of production. We're talking about those final goods and services, the ones that actually go to the user of the good. Okay, so they're gonna be produced during a certain year. So we'll measure GDP on a yearly basis to see it as a statistic to measure against other years. So we use this as a statistic that measures growth and we basically use it to measure the well being of a society, you know, growth in the society, whether G. D. P. Is bigger this year than last year. Um And generally we tend to think in economics, so economists tend to rationalize that the higher output, the higher GDP means happier citizens, higher output is happier citizens, basically higher output leads to a higher standard of living here. Okay, so let's go ahead and calculate GDP using what's called the expenditure approach. So the expenditure approach, it counts up all of the expenditures during a period. So expenditures, what money is spent during a period. So we break it into four categories here, four main categories of expenditures. So who is spending money during, during the period during the year? And that is how we'll calculate if we if we total up all the money that is spent on these final goods and services during the year, Well then we'll know what our GDP is. Another way to calculate it is to use the income approach. However, we're gonna be focusing here on the expenditures approach. They both end up at the same value because basically all the money being spent is money that's being earned by someone else. Right? So these have the total in total have to equal each other out expenditures and income. But the most common way we see this is the expenditures approach. Some of your textbooks go into the income approach and we'll have videos related to that. But this is the main way we want to think about it. So let's go through those four components of G. D. P. The first one here is consumption. And when we do our calculation, when we make it into an equation uh consumption, we we just put it as a C we label it as a C as the variable for consumption. And this is going to be spending by households on goods and services. So this is general spending most of the spending you do is going to be included in this consumption category when calculating GDP. Okay, so those expenditures that money you spend, uh, you know, going to the store, buying groceries, buying whatever goods and services you buy in general is going to be included in this consumption category. This is the biggest category of our GDP calculation. Now, one thing that gets excluded, one household purchase that gets excluded is the purchase of new construction. So when we're talking about like a new home that just got constructed this year, we're gonna exclude it from the consumption category. We're gonna include it in this next category. Investment. So, we may have talked about investment a little bit in previous videos, but if this is your first time seeing it, this investment is different than financial investments that you think of. So when we think about this, when we talk about investment in economics and economic investment, this is gonna be buying equipment, inventory, and structures. So things like factories, machinery, right, these kind of expenditures are going to be included in investment, uh, compare that to what you might think of as an investment on a day to day basis. A financial investment like stocks and bonds that's not included here. Okay, that is not that's not even included in the GDP calculation at all. We'll talk about why that's excluded later. Um, but this investment, we're talking about these kind of long term, uh, structural investments here on equipment and structures, things like that. So, generally think of it as business spending on long term growth. Right? Like long term assets. If you've taken an accounting class long term uh things like you know buildings and land and things like that. So the one thing that we excluded from consumption the new construction of homes for households, well we're gonna include it here. So new construction is included in investments. So this is like a household investing in the future as well. Right there investing by buying this new home that's gonna last them a long time. So that's included in the investment category. Next we have government purchases so government purchases we just leave that as a G. For government purchases and guess what? Government purchases are its spending by the government, spending on goods and services by local state and federal governments. Okay. Pretty self explaining Tory there. So what kind of goods do we see in this category? Well when they pay teachers salaries right? The government generally pays public school salaries building highways when they repair highways. The government is generally in charge of that military equipment. Right? These are things the government spends money on. And we're remember we're counting up all the expenditures in the economy during the year. So any money that the government spends is included in the G. D. P. As well. Now one thing that does not get included is what we call transfer payments are not included? Okay. And transfer payments is basically the government giving money or sort of welfare services. Things like welfare. It doesn't result in some sort of production. Remember our our definition up here for GDP its final goods and services produced. So that welfare that's received by the families. Well when they spend it it'll go into this consumption category, right? But the payments that the government makes to those families, it's not included in government purchases. It will eventually be included in consumption when the families spend the money. Okay so that's a little nuance there. And finally we have net exports and we label this one as N. X. For net exports. And this is when we talk about exports. Well the opposite is an import export. These things we sell to other countries imports is things coming in. So exports minus imports gives us our net exports. This could be a positive or a negative number depending on whether exports were bigger or smaller than imports. So just a definition here exports. These are goods produced domestically. So they're produced here in the U. S. But sold in other countries, they're sold abroad. The opposite is an import. Those are goods produced in other countries but sold domestically. So voila, we finally reached our GDP calculation here, look how amazing it looks. So we just add these four things. These are the four components of GDP all the consumption plus all the investment plus all the government purchases plus the net exports gives us our GDP for the year. Okay so when we talk about GDP we can use two different calculations to make GDP, we can do our nominal GDP and nominal GDP uses current prices to value all of this consumption, all of these, all of these components of GDP where real GDP. Well, it's gonna use what we call base year prices. Okay. And we're gonna get into more detail about nominal GDP and Real GDP and other videos. Um But it's worth mentioning here that there's two calculations for GDP. Now when you see GDP calculations on the test, sometimes it'll be as easy as this where they'll tell you numbers for consumption, they'll tell you numbers for investment, government, net exports. And you just have to add them up. But sometimes they'll tell you um like we might have seen in other videos, something like, oh we produced this many um apples and this many oranges and these are the prices of apples and oranges, calculate GDP. Well, you have to remember, it's just you have to calculate GDP, you just need to add up all the value of all the goods and services produced. So if they just produced apples and oranges. Well, we're just talking about consumption in this in this case, just apples and oranges. What what were produced apples and oranges, what was the value of those apples and oranges. That's gonna equal GDP. Okay, so there's a few different ways to do this. You'll see some practice problems related to that as well. Um But this is the formal definition here. So just a couple more things before we end this video, a few extra technicalities when we come to making these definitions um what we talk about GDP first is that note of final goods? We mentioned this that we only the final goods and services are included in GDP. Okay, what we have along the way are called intermediate goods. Okay, so imagine a company that purchases something. So let's say like in our example a greeting card company like hallmark, they purchase paper that they use to create greeting cards. So the paper they purchased is not included in GDP. While the greeting card, the value of the greeting card is included. Right? The paper is an intermediate good. It's not a final good in service. Right? So a lot of products are created using other products, right? If you're gonna build a car, we need to buy tires, we need to buy steel to produce the car, the engine, whatever we need to buy all these parts to create the car. But the final product is the car. So that's what would be included in G. D. P. Next. We have second hand sales. So if you're selling something on craigslist that's not included in GDP because that was not produced this year. The only time it's going to be included in GDP is the original purchase from the end user. So if you purchase a tv from walmart, it's included in GDP, but when you sell it on craigslist, it is not included. Right? So we'll keep track of it when it's finally sold to an end user and these second hand sales do not get included in GDP. Okay. And finally we mentioned this before when we were talking about investment financial transactions, so stocks and bonds, they are not included, not included in GDP. This is similar to transfer payments when we were talking about welfare. Um That's not an actual there's no actual thing being produced there. Right, We're just talking about financial assets, different stores of money rather than actual things being produced. Okay, so those are not included in GDP and that's not included in the investment section. So, one trick you might see, they might have, you calculate GDP and they have a mention of financial investments, such as stocks and bonds. Well, you would know that that's not included in the G. D. P. Calculation. Okay, so this is a pretty formal definition of G. D. P. Um but that it's a good video, it's a good uh synopsis of everything that goes into GDP here using the expenditure approach, let's go ahead and move on to the next video