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GROSS DOMESTIC PRODUCT IN DETAIL
Calculating GDP
In this
module, you will learn
- how to calculate the GDP
- how to use moneychimp.com to further understand money flow in the GDP - submodule includes 4-question GDP Money Flow Quiz
- how to calculate GDP in a practice example - submodule includes 1-question GDP Calculation Quiz
- how to understand the role of Personal Savings and how to use U.S. government information to verify the formula in the real world
Tutorial:
How to calculate the GDP
The
basic formula for calculating the GDP is:
Y = C + I +
E + G
where
Y = GDP
C =
Consumer Spending
I =
Investment made by industry
E = Excess
of Exports over Imports
G =
Government Spending
This
formula is almost self-evident (if you take time to think about it)!
GDP is
a measure of all the goods and services produced domestically. Therefore, to
calculate the GDP, one only needs to add together the various components of the
economy that are a measure of all the goods and services produced.
Many of
the goods and services produced are purchased by consumers. So, what consumers
spend on them (C) is a measure of that component.
The next component is the somewhat mysterious quantity
"I," or investment made by industry. However, this quantity is
mysterious only because investment does not have its ordinary meaning.
When calculating the GDP, investment does NOT mean what we normally
think of in the case of individuals. It does not mean buying stocks and bonds
or putting money in a savings account (S in the diagram). When calculating the
GDP, investment means the purchases made by industry in new productive
facilities, or, the process of "buying new capital and putting it to
use" (Gambs, John, Economics and Man, 1968, p. 168). This includes,
for example, buying a new truck, building a new factory, or purchasing new
software. This is indicated in the diagram by an arrow pointing from one
factory (enterprise) to another. In essence, it shows the factory
"reproducing itself" by buying new goods and services that will
produce still more new goods and services. NOTE: There is a money-flow
relationship between personal savings, S, and investment, I, but
this does not figure directly in calculating the GDP. See Exercise 3 below.
The
next component is E, or the difference between the value of all exports and the
value of all imports. If Exports exceeds imports, it adds to the GDP. If not,
it subtracts from the GDP. Thus, even if a nation's people work very hard to
produce products for exports, but still import more than they export, the
nation's GDP will be negatively impacted. This is one of the reasons trade
deficits are frequently a political target. Because the balance of trade can be
either positive or negative, we can rewrite the equation, showing the
components of E, using X for Exports and M for Imports:
Y = C + I +
(X - M)+ G
You may
see the formula for the GDP written this way, and it may be easier for you to
remember in this format.
The
final component is G. The government buys (with your tax money) goods and
services (G). These purchases are a measure of those goods and services
produced. Be aware that many people make the mistake of thinking that the money
paid in taxes and spent by the government is "lost" and therefore
subtracts from the GDP. Tax money may indeed be spent inefficiently but this
fact has no bearing on the calculation of the GDP.
Exercise
1: Understanding Money Flow in the GDP Components
Study
the diagram below (source: www.moneychimp.com).
The solid arrows indicate the components of the GDP, and the direction of the
money flows. The arrow indicating the Trade Deficit would be in the opposite
direction in the case of a Trade Surplus.
Source: www.moneychimp.com (labels added by MindTools)
Now go
to the interactive version of this diagram at http://www.moneychimp.com/articles/econ/gdp_diagram.htm.
At the MoneyChimp site, click on the various icons in the diagram (including
the arrows!) for more information about the U.S. GDP. Use the diagram to
answer the following questions. NOTE: The information given in the diagram for
the first two questions represents historical averages and may not reflect the
most current information. You may find the Glossary or other areas of
MoneyChimp useful as well.
1. What
portion of the GDP is accounted for by Consumer Spending?
2. What
percent of the GDP is "lost" or subtracted from the total due to the
trade deficit?
3. How
does the money "lost" due to the trade deficit find its way back to
the U.S.?
4. How
is "Investment" defined on the diagram?
Did you
find the answers? Check yourself with the Money Flow
Quiz!
Exercise
2: Practice Calculating the GDP
Atoll K
is small island nation. Its population total is 400, and it has 100 wage
earners who earn an average of $50 per year. Each wage earner spends $40 per
year buying local goods and services and $2.50 buying imports. The island
exports a total of $800 worth of goods. The Government tax rate is 10% and all
government money is spent on building infrastrcuture and supporting schools.
There is only one industry (uranium mining) on the island and it employs every
wage earner. The industry spends $600 each year on new mining equipment. What
is the GDP? Check your answer with the GDP
Calculation Quiz!
Exercise
3: Understanding the Role of Personal Savings and Using U.S. Government
Figures to Verify the Formula
Now,
let's look at the role played by personal savings. The diagram indicates that
personal savings (what we normally call "investment") is actually a
source of revenue for industry. This is because the money you put in the bank
is loaned to businesses so that they can put it to work. Money NOT circulated
in this way -- the money you stuff in a mattress -- would actually be
subtracted from the GDP. For the most part, however, people do not put money in
mattresses and the bank system uses the personal savings of individuals to give
industry its reservoir of money to work from. This is why economists say that
the amount of Savings is always going to be approximately equal to the amount
available for Investment. Savings and Investment can become out of balance when
there is more demand for investment money than what is available from domestic
savings. In that case, more money is borrowed from foreign sources.
NOTE:
Because additional Savings has the effect of supplying more money to industry,
some economists have argued that if we want to correct the negative effect of
the trade deficit (since it is subtracted from the GDP), we should encourage
Savings, which will indirectly boost Investment.
To see
the actual GDP figures for the U.S., go to http://www.gpoaccess.gov/eop/tables04.html.
You may find this a useful site for information. At this site, you can download
Excel Tables showing you the GDP from 1959 to the present. If you are adept at
moving data and eliminating unnecessary information, you can generate a chart
like the one below simply by editing the government-supplied chart. Notice that
the GDP calculation in the chart uses the same headings we gave above in the
formula for the GDP. An example calculation, made by plugging the chart entries
for the year 2000 into the formula is show below.
Y =
C + I
+ E +
G
9817.0 =
6739.4 + 1735.5
- 379.5 +
1721.6
Created
on ... February 24, 2004 Revised 3/13/2012
FISCAL DEFICIT AND CALCULATION
What is Fiscal Deficit? Fiscal Deficit is nothing but the difference between the money spent by the Government and the total income earned. Now,you can come to an idea that if the country has a fiscal deficit, then still the Government is not rich enough. How to calculate Fiscal Deficit? Let us consider the following example, If the Government earns Rs. 100 crores in a year, but spends 120 crores, then the Fiscal Deficit of the country is 20 crores. I guess, you can understand how to calculate the Fiscal deficit, by now. But as a matter of fact, Fiscal Deficit is usually not expressed in amount, rather in terms of percentage of GDP. So therefore lesser the Fiscal Deficit percentage, better is the country's growth. Now you have another doubt, i.e What is GDP? GDP is nothing but gross domestic product (GDP) or gross domestic income (GDI) and this is the term used to measure the country's overall economics output. You can calculate the GDP , with the help of this formula, GDP = consumption + investment + Government spending + (exports-imports) So, if we know the value of GDP, and the Fiscal value ( difference between expenditure and earnings), we can easily express the Fiscal Deficit in terms of GDP Reference http://factsdatabase.blogspot.com/2010/02/how-to-calculate-fiscal-deficit.html
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