Gross Domestic Product, or GDP is often considered the greatest measure of growth and production. Measured every quarter in both Canada and the United States, GDP is a rough estimate of the amount of output created in an economy.

To be more accurate, GDP is defined as the total value of all finished goods and services produced within a given year. This roughly estimates how much “stuff” consumers get to eat, as well as how much income earned domestically. International incomes are not included - even those earned by domestic workers in other countries. Alternatively, GDP can be thought of as the “value added” by each level of production for all final goods produced within the economy.

There are two models for measuring GDP, the expenditure model, and the income model. In theory, since GDP measures both income and expenditure within the economy (as well as total output of goods and services¹ these two measures should be identical; in practice there are a number of reasons this isn’t true².

GDP, when measured in an expenditure model, is defined by the formula C + I + G + NX, where “C” represents consumer spending (on final goods and services), “I” represents real investment (in creation of capital structures), “G” is government spending, and NX is net exports (exports minus imports). The primary reason post-Keynesian economists have divided “C” and “G,” in the accounts, rather than making them a single “S” for spending, is that it makes it easier to treat consumer spending as endogenous, while calling government spending exogenous, then consider how the economy would conform to different levels of government spending.

Let’s break the equation down in to more detailed explanations of each piece:

• Private Consumption refers strictly to the spending of private entities in the economy, this includes rent, food, clothing, and the entire range of expenses occurring to families and households, however, does not include the purchase of new houses, which would be measured as investment.
• Investment includes any activity which produces new capital. Purchasing financial instruments is considered saving (because, in fact, it is just a transfer payment), not investment, however, purchasing a new house, developing a new piece of software, or any other creation of goods from money is investment.
• Government Spending is all spending by governments at any level on final goods and services. This includes wages for public servants, but does not include transfer payments such as welfare.
• Net Exports is the total amount of purchases from other countries for final consumption, minus the total amount of stuff sold to other countries.

It’s important to consider the meaning of final consumption and finished good. When McDonald’s produces a hamburger, they are purchasing beef, buns, tomatoes, and everything else involved - these purchases are not counted in GDP - when they put them all together and sell you a burger for more than the sum of the costs of it’s parts (due to value added and profit), the final sale value is included in GDP. This ensures nothing is counted twice.

Furthermore, there’s a distinction between real GDP and nominal GDP - nominal GDP is the value of the total production in actual number values (”dollars”), while real GDP is a little bit more complicated. Real GDP is a measurement which aims to discover the entire value created by production, while holding constant for “dollar” values; to calculate real GDP, it is assumed that quantities of production have changed but prices have not. This is an interesting assumption, as it requires the definition of a base year in which certain goods may not have existed, or the capacity of the goods may have changed dramatically since then - simply put, it’s not very accurate for “technology” or often changing markets.

Real GDP is defined as a simple Prices in the Base Year times Quantity in the Current Year. For example, in a society which only produces apples, if in 2000 (the base year), 100 apples are produced at $1 a piece, the nominal GDP that year is $100. If then, in 2010, 150 apples are produced at $1.25 a piece, the nominal GDP is $187.50, but real GDP is only $150. Economic growth is $50.

1. This isn’t true either, because services produced in one’s own home - such as doing dishes, and making sandwiches are not included in GDP. Furthermore, the theoretical example of one having a maid clean their house, then marrying that maid (all-the-while, the maid continues to clean the house - now as a spouse, rather than a vendor) converts something which was included in GDP to something that is no longer. [↩]
2. Particularly the “inventory problem,” in that it’s assumed that a firm purchases their inventory, when really money has not changed hands. [↩]

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