Lesson 3ª


 

 

 

 

 

   
 HOW IS GDP MEASURED?

GDP is measured by two different approaches. However, both of these approaches obtain the same end result.

a) As a flow of expenses (end products): that's to say, where have the different goods and services gone during the fiscal year.

b) As a flow of income: how the income is distributed which has been generated during the production of the goods and services.

Why do both approaches coincide? We are going to try and explain it:

All productive processes have an end result (the elaboration of goods or services). However in these processes there are certain things that a company has (salaries, rent, capital interest rates, etc). The difference between the value of what has been produced and the companies expenses is the company's profit (which is the how the owner of the company perceives it).

Therefore, if we add all of the costs together (including the companies profit) they will be the same as the production value.

Lets analyze the composition of the GDP according to the two previous approahces:

a) As a flow of expenses

GDP = Consumption + Investment + Government Spending + Exports - Imports

Abbreviated form:

GDP = C + I + GS+ X - M

Consumption: the goods and services produced in the year that are acquired by families and companies for their final consumption. For example: a book, a chocolate bar, a washing machine, a car, the cost of a lawyer, a hair cut, a car wash, etc.

Investment: the goods acquired by companies to incorporate them in their productive structures. For example, a computer, a machine, a ship, a tractor, etc.

Just one consumer good can be destined to consumption or investment, depending on its use: for example, if a family acquires a car for its use you are talking about a consumer good, but if a company acquires a car for its sales team, then you are talking about an investment.

Government Spending: the goods and services acquired by Public Administration, either for their consumption (material for the office, cleaning and security services...), or as an element of investment (computers, the construction of motorways, hospitals...). Also included in this is the salary of civil servants.

It does not include, however, the expense of pensions: when they pay the salary of a civil servant they buy a service, their work (there is an economic transation), whilst when they pay a pension they are simply transferring income (they don't receive anything in exchange), which therefore does not contribute to the GDP.

Imports - Exports: the difference between what a country exports abroad (goods and services) and what it imports.

Exports are like a positive sign (they increase the GDP) as they are a product that has been elaborated in the country.

Whilst the imports are seen as a negative sign: they don't decrease the GDP, they simply compensate an amount entered in the books in consumption, investment or public expense which as it has been created abroad doesn't have to be included in the GDP.

Perhaps we can try and explain what we mean with an example:

If a Spaniard buys a Volvo (made in Sweeden) this purchase is registered in the GDP as "consumption". But as the car has not been made in Spain, it has been imported, it shouldn't be part of the GDP, therefore it is noted as an "import" (it is now taken off the consumption part of the GDP).

b) As distribution of income

Another way to measure the GDP is by adding the income that has been generated throughout the year deriving from economic activities.

GDP is equal to the sum of:

Salaries (worker's income).

Interest rates and income

Indirect taxes: VAT....(income that the state receives).

Depreciation or redeption (income that a company receives as compensation of the debilitation suffered by being inmobile).

Profits.