Components of GDP in the Expenditure Approach
The gross domestic profit can be defined as the value attached to all finished services and goods produced in the confines of a country within a specified time frame and in monetary terms. The GDP is oftentimes calculated annually. It is among the major indicators employed in the assessment of the strength of an economy in any given country (GDP and the Economy, 2014). There are several approaches of calculating the GDP of a country. These approaches include the income approach, the production approach and the expenditure approach. In the expenditure approach, the calculation of the country’s GDP is measured as a summation of 4 distinct categories of expenditure on output. These include; the gross private consumption expenditure [C], government spending (G), gross private investment (I) and the net exports (X-M). This can be summed up as C+I+G+(X-M) =GDP (GDP and the Economy, 2014). Private consumption comprises of every good or services purchased by all households. Under such, there includes services, durable goods and non-durable goods. It makes up almost two-thirds of the total GDP. Investments are calculates through a summation of fixed investment, residential investments and inventory investments. In the long run, all capital expires. This depreciation measures the decrease in the real value of capital. Fixed investment includes he purchases on all capital goods (machines, robots or factories). Raw materials are not part of this inclusion. Inventory investments are the changes in inventories in terms of goods on shelves in stores awaiting sale and raw materials that are not assembled yet into final products. Residential investments are the purchases of new homes in the household industry. Government spending accounts for the expenditure by the government bodies on new products and services. Transfer payments are not part of this expenditure. Net exports calculate the value of the total exports in a country less the total imports.
Categories excluded in GDP Calculation
The GDP is the main measure of goods produced in a country. The higher the GDP, the more a country is able to meet the unlimited needs and wants of its population. For a large economy like the United States, measuring the GDP can be hectic. Even though the GDP aims to determine the overall market value of all current products in theory, some components of the economy are not, in practice, included. Such components include; estimated value, past or future productions, illegal goods, home production and market transactions of economic production. These components are excluded from the calculation of the total GDP even though in real sense they are economic activities that yield goods and services.
Growth of GDP and Inflation
Inflation, just like GDP, is a very important indicator in an economy. The relationship between these two indicators is not clear due to a number of economic debates. Inflation is as a result of an increase or decrease in the amount of currency in an economy. Money gets less purchasing power when inflation is high. There is a notion that inflation occurs when there is a lot of money in the economy and less goods or services. This causes the prices to go up due to competition for limited items. This implies that when the GDP increases (growth in the total amount of goods and services), there should be a decrease in the prices or in simple terms deflation should occur. When the economy is growing at a very fast pace, shortages may occur due to higher demand that does not match the supply (GDP and the Economy, 2014).
GDP Growth and Unemployment
The growth rate of an economy is related t the unemployment rate of the same. In economics, Okun’s law tries to establish this relationship. According to this law, employment and output share a positive relationship. Employment can be calculated as the labor force excluding the unemployed. Therefore unemployment and output have a negative correlation. Due to the continued increase in the labor force size and productivity levels, real GDP growth is required to hold the rate of unemployment steady. Therefore, in order to reduce unemployment, the economy should grow at a pace relatively higher than its potential.
Economic Welfare and GDP
Whether as a personal opinion or as an economic school of thought, the GDP as a measure of progress badly overstates benefits seen through unequal economic growth. In the same manner, this measure of growth in output understates value of intangible services and products (Coyle, 2014). Due to these concerns, it is difficult to peg the welfare of a country on the national income. This can be evidenced by the fact that the global GDP has almost doubled in the last three decades. However, the level of unequal distribution is very high. Income distribution is not mentioned anywhere in the calculation of the national income trough the gross domestic product. In the same way, the GDP continues to ignore the negative economic effects of inequality (GDP and the Economy, 2014). In this measure, it does not matter whether the national income is captured by five people or the whole population, the GDP growth level will be recorded as the same. Therefore, the GDP measurement and the resultant annual growth levels do not reflect the economic welfare of the society.
Recommendation to Improve GDP
For GDP to be effective as a measure of national income, I would propose an inclusion of the rate of national income distribution per the average member of a society. This will mean that the measure will be able to capture how income is distributed and also take into consideration the rates of inequality in income distribution and production.
Coyle, D. (2014). The ups and downs of GDP. OECD Observer, 20-21.
GDP and the Economy. (2014). Survey of Current Business, 94(8), 1-5.