Expenditure Equals Income
Because firms pay out as income everything they receive as revenue from selling goods and services, total income, Y , equals total expenditure.
Y = C + I + G + NX
For a firm, the value of its production is the cost of the production, which equals the income generated by the production. So, the value of production equals income equals expenditure, or
GDP = Y = C + I + G + NX
Households use their income on consumption expenditure, saving, and paying net taxes. Therefore, it is the case that:
Y = C + S + NT
If everything is measured correctly, adding depreciation would yield GDP. But there often is a statistical discrepancy , the difference between the expenditure approach and the income approach. The difference is measured as the expenditure approach minus the income approach, so any statistical discrepancy is added to the sum to yield the income approach GDP. (1)
GDP and Related Measures of Production and Income
In addition to GDP, another macroeconomic measure of production is GNP.
- Gross national product , ( GNP ) is the market value of all final goods and services produced anywhere in the world in a given time period by the factors of production supplied by the residents of the country. So, pharmaceutical drugs produced in Ireland by a U.S. drug company is part of U.S. GNP but not part of U.S. GDP.
- U.S. GNP equals U.S. GDP plus net factor income from abroad.
- Disposable personal income is the income received by households minus personal income taxes paid. (1)
Uses of Real GDP
Real GDP can be used to compare the standard of living over time, to track the course of the business cycle, and to compare the standard of living among countries. (1)
The Standard of Living Over Time
Standard of living is measured by the value of goods and services that people enjoy, on average. Real GDP per person can be used to measure and compare the standard of living. Real GDP per person is real GDP divided by the population.
- In the United States in 2011, real GDP per person was 2.7 times larger than in 1961.
- In the United States in 2013, real GDP per person was 2.9 times larger than in 1961.
- Real GDP per person has doubled about every 30 years for the past 100 years, though its growth rate experiences short run fluctuations.
Potential GDP is the value of real GDP when all of the economy’s factors of production — labor, capital, land, and entrepreneurship — are fully employed. When some factors are unemployed , real GDP is below potential GDP. When some factors are over-employed , real GDP exceeds potential GDP. Potential GDP grows over time, though not at a constant rate. (1)
Tracking the Course of the Business Cycle
Fluctuations in the growth of real GDP reflect business cycles. A business cycle is the periodic but irregular up-and-down movement of total production and other measures of economic activity. Business cycles have two phases and two turning points:
- Expansion : The expansion phase is the period during which real GDP is increasing.
- Recession : The recession phase is commonly defined as a period during which real GDP decreases for at least six months, though the NBER has a broader definition.
- Peak : A peak is the highest level of real GDP yet attained. A peak is a turning point between an expansion and a recession.
- Trough : A trough is the temporary low-point in real GDP. A trough is a turning point between a recession and an expansion.
The Great Recession officially began in December 2007 and ended in June 2009, according to the National Bureau of Economic Research (NBER), which determines the start and end dates of U.S. recessions on the basis of a range of economic indicators. (1)
The Standard of Living Among Countries
To compare real GDP per person among countries, the real GDPs should be calculated using a common set of prices, called purchasing power parity prices. When this conversion is done U.S. real GDP per person is higher than in other advanced economies. (1)