Macroeconomic Concepts: GDP, Income, and Expenditure

Posted on Nov 28, 2024 in Economy

Gross Domestic Product (GDP)

Market value of all final goods and services produced within a country’s borders over a specific time period.

  • Valued at market prices, including indirect taxes (Ti) and excluding subsidies (Sb).

Consumption (C)

Household spending on goods and services to meet current personal needs.

  • Includes durable and non-durable goods and services.
  • Excludes new home purchases (included in Investment).

Investment (I)

Gross capital formation, or business spending on fixed capital acquisition, including new home purchases by households.

  • Investment equals the change in capital stock over a given period.
  • Fixed capital includes assets used in production processes (equipment and structures).
  • Capital stock includes goods held by companies awaiting sale or use in production.
  • Fixed investment can be gross (IB) or net (IN), depending on whether it includes depreciation (D): IB = IN + D.
  • Net investment (IN) expands productive capacity, while depreciation (D) maintains it.
  • Investment in stocks represents changes in stock levels.
  • Gross or net production depends on whether investment is defined as gross or net.
  • The GDP investment component includes gross fixed investment and changes in stocks.

Government Spending (G)

Government expenditure on goods and services to meet collective needs.

  • Excludes transfer payments (TR), such as pensions and unemployment insurance, as they don’t represent current productive activity.
  • Collective services are valued at production cost.
  • Primarily financed through direct (Td) and indirect (Ti) taxes.

Net Exports (NX)

Net balance between exports (X) and imports (Q).

  • NX = X – Q
  • Exports are added (external demand), and imports are subtracted (already included in domestic spending).
  • Corresponds to the trade balance: X > Q indicates a surplus, X < Q a deficit.

Output-Expenditure Identity

Reflects the equality between GDP and total expenditure:

  • GDP = C + I + G + X – Q
  • Alternatively: GDP + Q = (C + I + G) + X (total supply = total demand)
  • Also: GDP – (C + I + G) = X – Q (net exports = domestic output – domestic demand)
    • If GDP > (C + I + G), then X > Q and NX > 0
    • If GDP < (C + I + G), then X < Q and NX < 0

National Income (Y)

Sum of earnings by domestic residents for providing factors of production (wages, rents, interest, profits).

Calculating National Income from GDP

Y = GDP – Ti + Sb – D + RRN – RRE

  • Indirect taxes (Ti) are subtracted, and subsidies (Sb) are added to convert from market prices to factor cost.
  • Depreciation (D) is subtracted to obtain net income.
  • Income from domestic residents abroad (RRN) is added, and income of foreign residents in the national territory (RRE) is subtracted to focus on national income.

Personal Disposable Income (YD)

Income available for households to spend on goods and services.

Calculating Personal Disposable Income from National Income

YD = Y – Bnd – Tb – Css + T – Td + Tre

  • Retained earnings (Bnd), corporate profit taxes (Tb), and social security contributions (Css) are subtracted.
  • Transfer payments (T), direct taxes (Td), and net transfers from abroad (Tre) are added.

Simplifying Assumptions

  • No depreciation (D = 0)
  • No international income flows (RRN = RRE = 0)
  • No indirect taxes or subsidies (Ti = Sb = 0)
  • No corporate profit taxes, social security contributions, or retained earnings (Tb = Css = Bnd = 0)
  • No net transfers from abroad (Tre = 0)
  • Taxes (T) are net of transfers (T = Td – TR)

Simplified Macroeconomic Identities

  • GDP = Y
  • Y = C + I + G + NX
  • YD = Y – T