The largest expenditure component of u.s. gdp is

Consumption by consumers, investment by businesses, and government spending are the three major parts of our economy and of most economies. (Foreign trade, conducted by exporters and importers, is the remaining sector, which I'll discuss soon.)

The size of a nation's economy is the total value of the spending on goods and services in the nation in a year. This spending occurs in the form of transactions within and between these three sectors. The flip side of this spending is production, because you can buy only what has been produced. So we can also measure an economy based on its production. Therefore, when you add up all of these transactions—and the value of foreign trade—the result is gross domestic product, or GDP. The formula for GDP is:

• GDP = C + I + G + (Ex - Im)

EconoTalk

Gross Domestic Product is the sum of all spending on goods and services in a nation's economy in a year. The formula for GDP is: GDP = C + I + G + (Ex - Im), where “C” equals spending by consumers, “I” equals investment by businesses, “G” equals government spending and “(Ex - Im)” equals net exports, that is, the value of exports minus imports. Net exports may be negative.

Subsidies are transfer payments to assist industries that benefit the public, but might not survive or remain stable if operated for profit without subsidies. Farm products and rail transportation are subsidized in most modern economies.

The parts of the formula are simple:

• C = total spending by consumers
• I = total investment (spending on goods and services) by businesses
• G = total spending by government (federal, state, and local)
• (Ex - Im) = net exports (exports - imports)

C + I + G + (Ex - Im) currently equals over $10 trillion in the United States. That means the United States produces more than $10 trillion of goods and services within its borders every year.

You should know several things about GDP.

Spending by consumers, which economists call consumption or consumption expenditure, is by far the largest part of the U.S. GDP. It accounts for an average of about two-thirds of GDP in the United States. Also, consumption roughly equals household income, because people spend what they earn as income. (True, they also save some of it and they borrow to spend, but let's leave that aside for now.)

Business investment is the total amount of spending by businesses on plant and equipment, and it accounts for a little over 15 percent of total GDP. This might seem to be a relatively small portion of GDP for business, but it's an extremely important one. Businesses invest in productive equipment and that equipment typically creates jobs as well as goods and services. The wages and salaries that businesses pay to workers are not counted as businesses investment (“I”). That money is already counted in consumption (“C”) because that is the money that households are spending. Investment (“I”) includes only spending by businesses on goods and services, including raw materials, vehicles, offices and factories, and computers, furniture, and machinery.

Government spending on goods and services averages about 20 percent, or one fifth, of total GDP. The government takes in an amount equal to more than one fifth of GDP in taxes, but a portion of that money, equal to about 10 percent of GDP, goes to transfer payments rather than expenditures on goods and services. Transfer payments include Social Security, Medicare, unemployment insurance, welfare programs, and subsidies. These are not included in GDP because they are not payments for goods or services, but rather means of allocating money to achieve social ends.

Net exports for the United States are close to zero or, oftentimes, a bit negative. Yes, the United States exports a tremendous amount of goods, but it imports even more.

So the composition of GDP breaks down roughly as follows:

Each component of GDP is important. In this section, we examine the role and contribution of each component.

Excerpted from The Complete Idiot's Guide to Economics © 2003 by Tom Gorman. All rights reserved including the right of reproduction in whole or in part in any form. Used by arrangement with Alpha Books, a member of Penguin Group (USA) Inc.

To order this book direct from the publisher, visit the Penguin USA website or call 1-800-253-6476. You can also purchase this book at Amazon.com and Barnes & Noble.

Economic growth is measured in terms of an increase in the size of a nation's economy. A broad measure of an economy's size is its output. The most widely-used measure of economic output is the Gross Domestic Product (abbreviated GDP).

GDP generally is defined as the market value of the goods and services produced by a country. One way to calculate a nation's GDP is to sum all expenditures in the country. This method is known as the expenditure approach and is described below.

Expenditure Approach to Calculating GDP

The expenditure approach calculates GDP by summing the four possible types of expenditures as follows:

GDP   =  Consumption + Investment + Government Purchases + Net Exports

Consumption is the largest component of the GDP. In the U.S., the largest and most stable component of consumption is services. Consumption is calculated by adding durable and non-durable goods and services expenditures. It is unaffected by the estimated value of imported goods.

Investment includes investment in fixed assets and increases in inventory.

Government purchases are equal to the government expenditures less government transfer payments (welfare, unemployment payouts, etc.)

Net exports are exports minus imports. Imports are subtracted since GDP is defined as the output of the domestic economy.

Alternative Approaches to Calculating GDP

There are three approaches to calculating GDP:

• expenditure approach - described above; calculates the final spending on goods and services.

• product approach - calculates the market value of goods and services produced.

• income approach - sums the income received by all producers in the country.

These three approaches are equivalent, with each rendering the same result.

Final Sales as a GDP Predictor

Note that an increase in inventory will increase the GDP but possibly result in a lower future GDP as the excess inventory is depleted. To eliminate this effect, the final sales can be calculated by subtracting the increase in inventory from GDP. The final sales can be either larger or smaller than GDP. The change in inventory is an important signal of the next period's GDP.

Nominal GDP and Real GDP

Without any adjustment, the GDP calculation is distorted by inflation. This unadjusted GDP is known as the nominal GDP. In practice, GDP is adjusted by dividing the nominal GDP by a price deflator to arrive at the real GDP.

In an inflationary environment, the nominal GDP is greater than the real GDP. If the price deflator is not known, an implicit price deflator can be calculated by dividing the nominal GDP by the real GDP:

Implicit Price Deflator   =   Nominal GDP   /   Real GDP

The composition of this deflator is different from that of the consumer price index in that the GDP deflator includes government goods, investment goods, and exports rather than the traditional consumer-oriented basket of goods.

GDP usually is reported each quarter on a seasonally adjusted annualized basis.

GDP Growth

Countries seek to increase their GDP in order to increase their standard of living. Note that growth in GDP does not result in increased purchasing power if the growth is due to inflation or population increase. For purchasing power, it is the real, per capita GDP that is important.

While investment is an important factor in a nation's GDP growth, even more important is greater respect for laws and contracts.

GDP versus GNP

GDP measures the output of goods and services within the borders of the country. Gross National Product (GNP) measures the output of a nation's factors of production, regardless of whether the factors are located within the country's borders. For example, the output of workers located in another country would be included in the workers' home country GNP but not its GDP. The Gross National Product can be either larger or smaller than the country's GDP depending on the number of its citizens working outside its borders and the number of other country's citizens working within its borders.

In the United States, the Gross National Product (GNP) was used until the early 1990's, when it was changed to GDP in order to be consistent with other nations.

Which is the largest expenditure component of GDP?

What is the biggest expenditures component in the US economy quizlet?