2-1.1. Components of GDP

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From the course by University of Illinois at Urbana-Champaign

Country Level Economics: Macroeconomic Variables and Markets

240 ratings

University of Illinois at Urbana-Champaign

Country Level Economics: Macroeconomic Variables and Markets

240 ratings

Course 3 of 7 in the Specialization Managerial Economics and Business Analysis

This course discusses how macroeconomic variables affect individuals’ personal, professional, and public activities and lays the foundation for the analysis of the mechanisms that drive macroeconomic variables. It start in its first module by introducing the key macroeconomic variables and explaining how they are defined and measured in order to enable the students to interpret macroeconomic data properly. In the second module, the course offers a perspective for separating out various parts of the economy driven by different processes and for combining those components to develop a richer view of the whole. In particular, it applies this approach to the analysis of the relationship of the trade deficit with the budget deficit and private savings, offering insights about some key determinants of the balance of payments. The third and fourth modules focus on the analyses of the foreign currency and money markets to provide fundamental models of the interest rate and exchange rate determination. They also discuss how these variables interact with each other and with the macroeconomic conditions, particularly monetary policy and the expectations about the future trends in the economy. These analyses lay the foundation for more comprehensive models of the macroeconomy in the next course of the Managerial Economics and Business Analysis Specialization. At the end of this course, you will be able to: • Systematically assess the national and international economic environment in which you live and work. • Analyze macroeconomic issues using key tools. • Be a more effective professional in your line of activity. This course is part of the iMBA offered by the University of Illinois, a flexible, fully-accredited online MBA at an incredibly competitive price. For more information, please see the Resource page in this course and onlinemba.illinois.edu.

From the lesson

Module 2: GDP Components, Twin Deficits, and Balance of Payments

Expenditure is often different from income for individuals, but for the economy as a whole, aggregate income is always identical to aggregate expenditure. This has important implications for the functioning of the macroeconomy and the way policies affect it. The income-expenditure identity is also fundamental to the ways various part of the economy with different processes interact with each other. For example, it sheds a lot of light on the formation of the trade deficit and its connection with budget deficit and private savings.

2-1.1. Components of GDP10:27

2-1.2. The Roles of Government and the Rest of the World in the Macroeconomy8:08

Meet the Instructors

Hadi Salehi Esfahani
Professor of Economics and Professor of Business Administration
Department of Business Administration, College of Business

In this video, we're going to focus on components of GDP,

and introduce some details about

how various parts of the economy connect with each other.

There are four main types of expenditure on goods and services produced in any economy.

The first type is Consumption,

it's consumption by households usually.

Or we call it private consumption.

There's also Investment.

The third component is Government Expenditure.

Sometimes government expenditure includes;

investment by the government,

or public investment but,

it could be also that investment includes both public, and private investment.

And finally, the fourth component is Net Exports, exports minus imports.

We separate out these different parts of expenditure because they behave differently.

They depend on different factors,

and we need to understand how each one is determined in order

to figure out how GDP as a whole is determined.

Of course, one can think about more detailed components for example,

consumption could be consumption and durable goods versus non-durable goods.

Or, investment could be divided between investment and equipment,

and software and buildings,

government expenditure has its own components,

net export has its own components.

One can break down these categories into finer details.

However, and that will make the model very complicated,

analysis becomes very involved and therefore,

we just stick to these broad categories in

order to make it easier to understand the main forces at work.

Most of the factors that work on

different components of consumption are similar to each other,

and therefore we are going to focus on consumption as a whole, for example.

If in some cases breaking up these categories into finer subcategories is helpful,

we're going to discuss it at that juncture.

Let's first focus on, Consumption versus Investment.

For this purpose, let's go to the model we developed in module one,

we said that firms produce goods and services,

sell it to households,

and households spend their money on those goods and services,

which we called consumption or household

expenditure and that goes through the product market.

Households buy goods and services in the product market,

and the money ends up with the firms.

The firms produce goods and services using labor,

capital, and other factors,

factors of production, and for that they have to pay households,

that we called income.

And that works through the factor market.

Now, there's another type of expenditure in the economy other than consumption,

which is called Investment.

Entrepreneurs, firms who want to expand production capacity,

need goods and services,

and spend money on those.

That money also goes to the firms.

In order to finance those investments,

entrepreneurs and firms need resources from summer.

That money typically comes from households.

Households save, and their savings go through the,

what we call the Capital Market that connects savers with investors,

and investment can be realized using the resources saved by the households,

or the income part of the income that is being saved by the households.

Let me emphasize the definition of investment here because

it's different from the term investment that we use in everyday conversation.

If you have some money and buy some stocks,

you might say that,

''I invested in the stock market''.

But, that's not the sense in which investment is done here.

That act to set aside some of your income and buy some financial instrument,

that's called Saving.

That's this step.

Active investment is, active borrowing,

or using your own resources,

using current resources, in order to create production capacity for future production,

for future value creation.

That's different from saving,

and it's also driven by different factors.

Just think about the role of interest rate for example.

If interest rate goes up and you're an investor,

the cost of investment for you goes up,

and therefore you may invest less.

But, if you're a saver,

you're the receiver of the interest rate.

The impact on you is going to be very different than the impact on the investor.

Now, that we've understood these two parts,

let's go forward and look at the numbers.

Notice here that I'm not introducing the rest of the world,

or the government and government expenditure or net exports.

I just want to focus on Consumption versus Investment,

and I'm going to combine public and private investment,

and private and public consumption.

Here are the numbers for GDP consumption and investment per capita in 2017.

In that year, consumption,

total private and public,

was $49,500, roughly 83 percent of U.S. GDP or per capita GDP.

Investment was $11,800, total private and public.

It was roughly 20 percent of GDP,

and the GDP per capita itself was $59,500 which is 100 percent of GDP per capita.

Notice here that, the percentage of

consumption and investment add up to more than 100 percent.

That's because, we have not taken into account trade deficit.

Trade deficit enables the United States to consume and invest more than it produces.

And, that's roughly three percent of GDP.

Let's also take a look at historical figures.

Total consumption in the U.S was about 75 percent of GDP in the mid 70s.

Before that, it used to be somewhat higher especially during the Great Depression,

95 percent of GDP was consumption,

because there was no investment,

very little investment at the time.

And, as the economy grew after World War 2,

percentage of consumption as a percentage GDP went down somewhat,

but since 1980, there's been a rising trend.

To which we are going to come back to see why consumption has grown as a share of GDP.

Total Investment has been roughly around 20 percent of GDP,

in the 60s and 70s up to recently it has been somewhat higher than 20 percent but,

nowadays it hovers around 20 percent private and public investment together.

During the Great Depression as I mentioned earlier,

there was very little investment.

The investment that was done about 5 percent of GDP,

was essentially replacing some worn out equipment

or maintaining enough investment to just maintain some parts of the capital stock,

not a whole lot of new investment.

So, let me summarize this.

Except during major recessions in the U.S,

Investment has been around 20 percent of GDP.

Somewhat higher in the 60s, and 70s.

Since 1980, total consumption has been rising especially

as it has risen above 80 percent of GDP in the U.S. And,

during recessions typically, the share of investment declines,

and the share of consumption rises.

Now, looking at this graph and thinking about these trends,

let me ask you a question.

Which one of the factors that they list here below from A to E,

do you think explains the rise of consumption GDP ratio since the 1980s?

Was it government spending that went up?

Was it population that has been aging and spending more?

Could it be because asset prices went up in the U.S. stock market house prices go up?

Maybe, both B and C,

or none of the above.

Maybe, there's been the long term recession in the U.S,

and that's why the ratio of consumption to GDP has gone up.

Now, that you've thought about this,

let me give you my take on this.

My sense is that actually,

the best answer is

the the aging of population means there are

a lot of retired people who are consuming but not producing.

And that has increased the share of consumption in total production.

Also, stock prices and house prices in the U.S. have

risen and people are feeling richer than they were before.

At least people who own stocks or assets,

and they spend a lot more a share of their income.

They don't save as much because,

they don't feel that they need a whole lot of saving.

Their assets are already taking care of them,

and provide them with enough wealth for retirement.

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