GDP is the market value of final output (What GDP Counts). One way to add it up is to ask who bought that output. Every final buyer falls into one of four groups.
Key idea
$$GDP = C + I + G + NX$$ Consumption ($C$) is household spending on goods and services. Investment ($I$) is spending on new capital goods, new homes and additions to inventories. Government purchases ($G$) are goods and services bought by all levels of government. Net exports are exports minus imports: $NX = X - M$.
Why it works
Why subtract imports? Not because imports "shrink" the economy. When a family buys a \$600 phone made abroad, that \$600 is already inside $C$. It was not produced here, so GDP must take it back out. Subtracting $M$ removes foreign production that was counted in $C$, $I$ or $G$. Exports are added because they are made here but bought by foreigners, so they appear in none of the other three.
| Component | Includes | Does not include |
|---|---|---|
| C | groceries, cars, haircuts, rent, medical care | buying a new house (that is I) |
| I | new machines and buildings, new homes, inventory growth | stocks and bonds (financial assets) |
| G | teachers’ pay, roads, military equipment | Social Security and other transfer payments |
| NX | exports minus imports | — |
Worked examples
Worked example: Adding up GDP
In billions of dollars: $C = 700$, $I = 180$, $G = 220$, exports $= 120$, imports $= 150$. Find GDP.
- Net exports: $NX = 120 - 150 = -30$.
- $GDP = 700 + 180 + 220 + (-30) = 1{,}070$.
Answer: \$1,070 billion
Worked example: Leaving out what does not belong
Data in billions: consumer spending 500, new business equipment 70, new homes 50, inventories fell by 10, government purchases 160, transfer payments 110, stock purchases 40, exports 80, imports 90. Find GDP.
- Investment: $70 + 50 + (-10) = 110$. A fall in inventories is negative investment: goods made in earlier years were sold.
- Leave out transfers (110) and stock purchases (40): neither buys new production.
- $GDP = 500 + 110 + 160 + (80 - 90) = 760$.
Answer: \$760 billion
Common mistake
Treating "investment" as buying stocks, or thinking imports are subtracted because they hurt the economy. In GDP, investment means new capital goods, new homes and inventory growth. Imports are subtracted only because they were already counted in $C$, $I$ or $G$. Check: if you add an import's price into $C$ and subtract it in $M$, it nets to zero, as it should for something not made here.