Reading 14. Aggregate Output, Prices, and Economic Growth
Learning Outcome Statements
a. calculate and explain gross domestic product (GDP) using expenditure and income approaches;
b. compare the sum-of-value-added and value-of-final-output methods of calculating GDP;
c. compare nominal and real GDP and calculate and interpret the GDP deflator;
d. compare GDP, national income, personal income, and personal disposable income;
CFA Curriculum, 2020, Volume 2
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Subject 2. The Components of GDP and Related Measures
There are two ways of measuring GDP. GDP derived by these two approaches will be equal.
The expenditure approach totals the expenditures spent on all final goods and services produced during the year. Under this approach, GDP is a measure of aggregate output. There are four components of GDP under this approach:
- GDP = C + I + G + (X - M)
- C (personal consumption expenditures): This is the largest component with this approach: durable goods, non-durable goods, and services.
- I (gross private domestic investment): The flow of private sector expenditures on durable assets plus the addition to inventories during a period. It is the production or construction of capital goods that provide a flow of future service. It indicates the economy's future productive capacity.
- G (government consumption and gross investment): Government purchases, not including transfer payments. It includes both (1) expenditures on such items as office supplies, law enforcement, and the operation of veteran hospitals and (2) the capital purchase of long-lasting capital goods such as missiles, highways, and dams for flood control. Government expenditures, which include transfer payments like social security, are not equal to government consumption.
- E - M (net exports to foreigners): This is exports minus imports. Exports are domestically produced goods and services sold to foreigners. Imports are foreign-made goods and services purchased by domestic consumers, investors and governments. When measuring GDP using the expenditure approach, we must add exports and subtract imports. Net exports may be either positive or negative.
GDP can be measured either from the value of the final output or by summing the value added at each stage of the production and distribution process. The sum of the value added by each stage is equal to the final selling price of the good.
Under the income approach, GDP is a measure of aggregate income. It is calculated by summing the income payments to resource suppliers and the other costs of producing those goods and services. It includes employee compensation (wages and salaries), self-employment income, rents, profits and interest, etc. Employee compensation is the largest source of income generated by the production of goods and services.
Personal income is the total income received by domestic households and non-corporate businesses. It is available for consumption, saving, and payment of personal taxes. Personal disposable income is an individual's available income, after personal taxes are paid, that can be either consumed or saved.
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GDP is the output of CIGarettes plus net exports