AP Macro: How to Calculate GDP

In AP Macroeconomics, there are three main indicators that you learn about: GDP, Unemployment, and Inflation.

We'll focus on the first of these three: GDP or Gross Domestic Product. GDP represents the dollar value of all final goods and services produced within a country’s borders in a given year. For example, the nominal GDP (GDP not adjusted for inflation) of the United States in 2018 was $20.89 trillion. So, how do economists actually find numbers like this? How is GDP calculated?

Economists have devised two different ways to calculate the GDP of a country, which is listed below.

Expenditure Approach (more important for AP Macro)

• GDP = C + I + G + Xn.
• In words, GDP = Consumption + Investment + Government spending + Net Exports
• Consumption: Money spent on the purchase of goods and services by consumers
• Investment: The money invested in capital goods/new buildings
• Government Spending: The amount of government spending in the economy
• Net exports - a country's balance of trade, (exports - imports). When positive, a country is exporting more than it imports, and vice versa

Let's think about this, and why it makes sense for calculating GDP. GDP, as previously defined, is the dollar value of all final goods and services produced domestically in one year. Therefore, we can calculate the GDP by calculating the dollar value of how much money people spent that year. For example, if someone spends $5 on a new chair, it counts towards GDP (note: the chair MUST be new! You'll soon learn why that is). Similarly, businesses that invest in physical capital like a pizza shop buying a new $1000 oven counts towards GDP. Government spending and Xn have similar rationales.

Income Approach

• GDP = W + I + R + P
• In words, GDP = wages + interest income + rent + profits + indirect business taxes + capital consumption allowance.
• Wage = the number of money people earned from their jobs
• Interest Income = Money earned from bank deposits
• Rent = Money earned from renting properties
• Profits = (revenue - cost), the amount of money made by a business

Income Approach = Expenditure Approach

You may think to yourself, what's the difference between the income approach and expenditure approach? They both calculate GDP so why are there two different formulas? Well, you would be right in thinking that there isn't any difference! The two formulas should (in theory) calculate the EXACT SAME NUMBER! Why is this? It's actually quite simple. Every time you buy something (an expenditure), someone will earn that money either in the form of profits, wages, rent, etc. Thus, every dollar expended is to someone else income! For example, let's say you go to a diner and order a $10 hamburger. While to you you spent $10, to the diner they EARNED $10! This concept is one and the same across economics.

Well, that’s it for this article! Good luck on your AP Macroeconomics exam!