Two different approaches are used to calculate GDP. In theory, the amount spent for goods and services should be equal to the income paid to produce the goods and services, and other costs associated with those goods and services. Calculating GDP by adding up expenditures is called the expenditure approach, and computing GDP by examining income for resources (sometimes referred to as gross domestic income, or GDI, is known as the resource cost/income approach.

Expenditure Approach
The expenditure approach utilizes four main components:

Consumption (C) - These are personal consumption expenditures. They are typically broken down into the following categories: durable goods, non-durable goods, and services.

Investment (I) - This is gross private investment; it is generally broken down into fixed investment and changes in business inventories.

Government (G) - This category includes government spending on items that are "consumed" in the current period, such as office supplies and gasoline; and also capital goods, such as highways, missiles, and dams. Note that transfer payments are not included in GDP, as they are not part of current production.

Net Exports - This is calculated by subtracting a nations imports (M)from exports (X). Imports are goods and services produced outside the country and consumed within, and exports are goods and services produced domestically and sold to foreigners. Note that this number may be negative, which has occurred in the U.S. for the last several years. Net exports for the U.S. were minus $606 billion during calendar year 2004 (as per Bureau of Economic Analysis, U.S. Department of Commerce June 29, 2005 press release).

Formula 4.1

GDP = C + I + G + (X - M)

Resource Cost/Income Approach
To calculate Gross Domestic Income (GDI), first consider how revenues received for products and services are used:

1. Pay for the labor used (wages + income of self-employed proprietors)
2. Pay for the use of fixed resources, such as land and buildings (rent);

3. Pay a return to capital employed (interest);

4.Pay for the replenishment of raw material used.

Remaining revenues go to business owners as a residual cash flow, which is used to replenish capital (depreciation), or it becomes a business profit. So with the resource cost/income approach, GDP (or GDI) is calculated as wages, rent, interest and cash flow paid to business owners or organizers of production.

So GDP by resource cost/income approach = wages + self-employment income + Rent + Interest + profits + indirect business taxes + depreciation + net income of foreigners.

Formula 4.2
GDI = wages + self-employment income + Rent + Interest + profits
+ indirect business taxes + depreciation + net income of foreigners

The above formula is probably hard to memorize, so at least try to remember this relationship - GDI = wages + rent + interest + business cash flow

Total GDP figures should be the same by either method of calculation. But in real life, things don't always work out this way. Official figures usually have a category called "statistical discrepancy", which is needed to balance out the two approaches.



Nominal vs. Real GDP, and the GDP Deflator

Related Articles
  1. Insights

    How To Calculate The GDP Of A Country

    A nation’s gross domestic product measures the monetary value of all of the goods and services it produces.
  2. Insights

    How To Calculate The GDP Of A Country

    We explain how to calculate the GDP of a country using two different approaches.
  3. Insights

    Why Investors and Economists Care About GDP

    Gross Domestic Product is the total dollar value of all goods an economy produces over a given time.
  4. Insights

    How The GDP Of The US Is Calculated

    The US GDP may not be a perfect economic measure, but the ability to compare it to prior periods and other countries makes it the most applicable.
  5. Insights

    How Is The GDP Of India Calculated?

    India is a front-runner among developing economies. Investopedia explains how India calculates its GDP, an indicator of economic health and performance.
  6. Trading

    Calculating the GDP Price Deflator

    The GDP price deflator adjusts gross domestic product by removing the effect of rising prices. It shows how much an economy’s GDP is really growing.
  7. Trading

    Trading GDP Like A Currency Trader

    Investors that understand and utilize the U.S. GDP report have a significant advantage over those that don't.
  8. Insights

    The GDP and its Importance

    GDP is an accurate indication of an economy's size. Few data points can match the GDP and its growth rate's conciseness.
  9. Taxes

    What is Gross Income?

    Gross income is an individual’s total income before taxes and other adjustments are considered.
Trading Center