GDP is one of the major concepts in the economic world. It can be defined from three different approaches, but the result is the same in all cases. The first of them, product approach, sums outputs of every enterprise’s class to arrive at a total. Expenditure approach is based on the principle that all products must be purchased by someone, which is why the total product value is equal to people’s total expenditures for buying things. The last approach, income, is founded on a principle that incomes of productive factors are equal to the value of their products, which is why GDP value is obtained through finding the sum of producers’ income.
On the whole, GDP is a complex concept that involves many different forms of spending on domestically produced services and goods. In order to understand and analyze it properly, economists distinguish between the following GDP components: consumption (C), investment (I), government purchases (G) and net exports (NX). GDP formula thus takes the following form: Y = C + I + G + NX (Mankiw, 2011). Below I will describe and analyze each of the above mentioned components.
The first component, consumption, represents households’ expenditures on services and goods except for the purchase of houses. The goods in this component may be of two kinds – durable and non-durable. Such goods as appliances and automobiles lie in the first category, while clothing and food are regarded as nondurable goods. Consumption involves such services as medical care and haircuts. This component of GDP affects each and every person, as it deals with direct expenditures everyone performs.
The next component is investment. Although this concept is well-known to all people in the context of finance, in GDP it is defined in a different way – it is purchase of goods that are further used for production of more services and goods. Thus, it represents various business investments into equipment. An example of this component is purchase of software, construction of a new mine, purchase of machinery, etc. In here households’ purchase of houses is also included. This component also considerably affects people, as the quality of such investments influences the quality of products they get as a result.
The third component is government purchases, which includes spending on services and goods by state, local and federal governments. Example of this component is salary of government workers and expenditures on public works. It is necessary to state that transfer payments, such as unemployment benefits and social security are not included in this component. Government purchases affect people, as a lot in our daily life depends on the public servants. They make our life safe and perform many other important functions.
The last GDP component is net exports, which represents expenditures on domestically produced goods by foreigners (exports) minus spending on foreign goods by domestic residents – imports (Mankiw, 2011). An example of this component’s constituent is sale of a Boeing to another country, which will increase the net exports. Imports are subtracted from exports, as they are already involved in the other components. This component also affects all people, as good rate of exports creates positive country’s image and contributes to better level of life people enjoy.
Mankiw, N.G. (2011). Principles of Macroeconomics. Stamford: Cengage learning.