GDP is a measure of both output and income. The revenues that firms derive from the sale of goods and services are paid directly to resource suppliers in the form of wages, self-employment income, rents, profits, and interest.

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.

Practice Question 1

For the purposes of calculating GDP, gross private domestic investment includes ______.

A. the value of new residential construction
B. purchases of stock and/or government bonds
C. purchases of new automobiles

Correct Answer: A

Investment does not include the purchase of stocks or bonds, which are considered saving, not investing.

Practice Question 2

Which of the following is not included in government consumption and gross investment?

A. Operation of veteran hospitals by the government
B. Purchase of missiles
C. Payment of social security benefits

Correct Answer: C

Transfer payment is not included.

Practice Question 3

Disposable income equals ______.

A. net GDP per capita minus personal taxes
B. personal income minus personal taxes
C. GDP minus personal income and federal taxes

Correct Answer: B

Disposable income is the income available to individuals after personal taxes. It can be either spent on consumption or saved.

Practice Question 4

Which statement is true?

A. Not all personal income is available for either consumption or saving.
B. Gross domestic product equals the sum of consumption, investment, and government expenditure.
C. GDP is a static concept since it measures the market value of production and this value is fixed (not variable) for a country.

Correct Answer: A

A is true. You must pay taxes. Disposable income is available for either consumption or saving.
B is false: + net exports.
C is also false; GDP is a flow concept since the market value of production flows through the economy's factories and shops each year.

Practice Question 5

GDP measures aggregate ______.

I. output
II. income
III. expenditure

Correct Answer: I, II and III

They all refer to different ways of describing the same quantity.

Practice Question 6

A consumer purchases a new house for his own family to live in. The price is $600,000 and it will last for 60 years. Under the expenditure approach, ______

A. personal consumption expenditures will be added to by $600,000, since the house is a personal expenditure, not business goods.
B. personal consumption expenditures will be added to by $10,000 ($600,000 / 60 years), since the house is expected to last for 60 years.
C. gross private investment will be added to by $600,000, since the house can be seen as an investment.

Correct Answer: C

Many goods possess both consumer- and investment-good characteristics. There is not always a clear distinction between the two. National accounting procedures have rather arbitrarily classified household purchases except housing as personal consumption. A house is an investment good because it will also provide a stream of services long into the future.

Practice Question 7

What is the GDP in this example?

A. $780
B. $870
C. $865

Correct Answer: B

GDP is calculated here by summing personal consumption (200), gross private domestic investment (500), government consumption and investment (100 + 40), and net exports (exports (120) - imports (90)) = $870.