Short on time? This page is the recap. For explanations, the circular flow diagram and worked examples, use the full study guide.
Recap
- GDP: the market value of all final goods and services produced within a country in a given period.
- Nominal GDP uses the prices of the same year: add price × quantity for every final good.
- Circular flow: households sell resources to firms in the factor market and buy goods and services in the product market. Money flows one way; goods, services and resources flow the other way.
- One person’s spending is another person’s income, so total spending = total income = value of output.
- Leakages: saving, taxes, imports. Injections: investment, government purchases, exports.
Key relationships
| Approach | Formula | Watch out for |
|---|---|---|
| Expenditure | GDP = C + I + G + Xn | Xn = exports − imports; can be negative |
| Investment (I) | new capital goods + new housing + change in inventories | shares and bonds are not investment |
| Government (G) | purchases of goods and services only | transfer payments are excluded |
| Income | GDP = wages + rent + interest + profit | profit is income too |
| Value added | value of output − intermediate goods bought | sum of value added = price of final good |
| Nominal GDP | Σ (price × quantity) of final goods | leave out intermediate goods |
Not counted in GDP
| Excluded | Why |
|---|---|
| Intermediate goods | already inside the final price (double counting) |
| Used goods | produced in an earlier year |
| Shares, bonds, bank deposits | financial transactions, not production |
| Transfer payments | nothing produced in return |
| Nonmarket activity (Topic 2.2) | no market transaction to record |
Mistakes to avoid
- Calling share purchases “investment”.
- Putting new houses in C. They belong in I.
- Adding transfer payments to G.
- Adding imports instead of subtracting them.
- Adding every sale in a supply chain. Use final goods or value added.
- Forgetting a fall in inventories is a negative part of I.
Quick self-check
VD is the valda, the currency of the fictional country Valdoria used in the study guide.
- C = 300, I = 80, G = 100, exports = 40, imports = 55 (VD billion). What is GDP? (VD 465 billion)
- A firm sells output for VD 90 and buys VD 35 of intermediate goods. What is its value added? (VD 55)
- Wages 400, rent 30, interest 50, profit 120 (VD billion). What is GDP by the income approach? (VD 600 billion)
Next: practice questions.