by Barnaby Meins

Created on: January 04, 2009

GDP, short for Gross Domestic Product, is a measure of aggregate output in national income accounts. It is often used in macroeconomics to find the production of an economy. GDP can be calculated in three ways, although all of them will give the same result.

First, it is the value of the final goods and services produced in the economy during a given period. Also, it can also be found as the sum of value added in the economy during a given period. In this second method, GDP is the sum of the differences in the value of a firm's production and the value of the intermediate goods used in production. Lastly, GDP can be expressed as the sum of the incomes in the economy during a given period, which is total sum wages of employees and profit of employers.

Specifically in the goods and service market, the Income-Expenditure Identity can be used to calculate the GDP. This identity is stated as GDP = C + I + G + NX, where C is Consumption expenditure, I is Investment, G is Government expenditure and NX is Net exports. It is assumed here that all firms produce goods and services, which can then be used by consumers for consumption, by firms for investment, or by the government. This implies that firms are willing to supply and demand in that market.

Consumption (C) is defined as the goods and services purchased by consumers. Investment (I) or fixed investment is the purchase of capital goods or the sum of nonresidential investment and residential investment. Government Spending (G) is defined as purchases of goods and services by the government. However, G does not include government transfers, nor interest payments on the government debt. Net exports (NX), otherwise known as the trade balance, is the difference between exports and imports.

Exports are the purchases of domestic goods and services by foreigners while imports are the purchases of foreign goods and services by consumers, business firms and the government. A trade surplus occurs when exports are more than imports whereas a trade deficit happens when imports are more than exports. In the rare case when exports are equal to imports, there is a trade balance. When the economy is closed, meaning that it does not trade with the rest of the world, both imports and exports are zero, such that GDP = C + I + G.

Consumption (C) is usually positively correlated to the amount of disposable income, which is the income that remains once consumers have paid taxes and received transfers from the government. Government spending

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