💶AP Macroeconomics Review
AP Macro: How to Calculate GDP
AP Macro: How to Calculate GDP
In AP Macroeconomics, there are three main indicators that you learn about: GDP, Unemployment, and Inflation.
We'll focus on the first of these three: GDP or Gross Domestic Product. GDP represents the market value of all final goods and services produced within a country’s borders during a given period of time. For example, the nominal GDP (GDP not adjusted for inflation) of the United States in 2018 was $20.89 trillion. So, how do economists actually find numbers like this? How is GDP calculated?
Economists have devised two different ways to calculate the GDP of a country, which is listed below.
Expenditure Approach (more important for AP Macro)
- GDP = C + I + G + Xn
- In words, GDP = Consumption + Investment + Government spending + Net Exports
- Consumption (C): household spending on final goods and services.
- Investment (I): spending on new capital goods, new residential construction, and inventory changes; this does not mean purchases of stocks or bonds.
- Government spending (G): government purchases of final goods and services; transfer payments such as Social Security or unemployment benefits are not included because they are not payments for current production.
- Net exports (Xn): exports minus imports.
Let's think about this, and why it makes sense for calculating GDP. GDP, as previously defined, is the market value of all final goods and services produced domestically during a given period of time. Therefore, we can calculate GDP by calculating the dollar value of how much money is spent on those final goods and services. For example, if someone spends $5 on a new chair, it counts towards GDP. Used goods are not included in GDP because GDP measures current production. A used chair was counted in GDP when it was first produced and sold, so counting it again would be double counting. GDP includes only final goods and services produced in the current period. Similarly, businesses that invest in physical capital like a pizza shop buying a new $1000 oven count toward GDP. Government spending and Xn have similar rationales.
Income Approach
- GDP = wages + interest + rent + profit + indirect business taxes + depreciation (capital consumption allowance).
- Wages: compensation paid to labor.
- Interest: interest income received by savers/lenders.
- Rent: income earned from the use of property.
- Profit: income earned by firms/entrepreneurs.
- Indirect business taxes: taxes on production and sales, such as sales taxes, that raise market prices.
- Depreciation (capital consumption allowance): the value of capital goods used up or worn out during production.
Income Approach = Expenditure Approach
You may think to yourself, what's the difference between the income approach and expenditure approach? They both calculate GDP so why are there two different formulas? Well, you would be right in thinking that there isn't any difference! The two formulas should (in theory) calculate the EXACT SAME NUMBER! Why is this? It's actually quite simple. Every time you buy something (an expenditure), someone will earn that money either in the form of profits, wages, rent, etc. Thus, every dollar expended is someone else’s income! For example, let's say you go to a diner and order a $10 hamburger. While to you you spent $10, to the diner they EARNED $10! This concept is one and the same across economics.
On the AP Macroeconomics exam, be especially careful not to count things that are not part of current production. Common traps include used goods, financial asset purchases like stocks and bonds, and transfer payments. If no new final good or service is produced, it does not directly count in GDP.
Well, that’s it for this article! Good luck on your AP Macroeconomics exam!