Question

Suppose consumption is \(\$ 2,000\) billion, investment is \(\$ 700\) billion, government purchases are \(\$ 1,200\) billion, export spending is \(\$ 100\) billion, and import spending is \(\$ 150\) billion. What does GDP equal?

Short answer

The GDP equals \$3850 billion. This is calculated by adding consumption, investment, government purchases and the trade balance (exports - imports).

Step-by-step solution

Understand the GDP formula

The formula for calculating GDP is as follows: GDP = Consumption + Investment + Government purchases + (Exports - Imports). You should understand that this formula includes all areas of the economy: the consumption of individuals, investments made by businesses, government spending and net exports.

Substitute the given values into the GDP formula

Now, substitute the given values into the GDP formula: GDP = \$2000 billion (consumption) + \$700 billion (investment) + \$1200 billion (government purchases) + (\$100 billion (exports) - \$150 billion (imports)).

Calculate the GDP

Now, perform the calculation. Start with the subtraction inside the bracket: \$100 billion - \$150 billion = -\$50 billion. This number is negative because the amount of imports is greater than the amount of exports, resulting in a trade deficit. Then, perform the addition: \$2000 billion + \$700 billion + \$1200 billion - \$50 billion.

Key concepts

Understanding Consumption in GDP

Consumption is one of the key components when calculating Gross Domestic Product (GDP). It represents the total value of all goods and services consumed by households. This includes everyday items like food, clothing, and healthcare.

To visualize it, think about everything an average family buys in a year. Add all these purchases together, and you get the consumption part of GDP. It is often the largest component, reflecting the daily needs and preferences of the population.

• Durable goods: Items like cars and appliances that last more than three years.
• Non-durable goods: Short-lived items such as groceries and clothing.
• Services: Intangible products such as medical care, education, and financial services.

In our example, consumption is given as $2000 billion, showing strong consumer activity in the economy.

Investment's Role in GDP

Investment refers to the purchase of goods that will be used for future production. This can include machinery, tools, buildings, and technology. It is a critical part of GDP because it reflects how much businesses are spending to improve their future productivity and capacity.

Imagine a company buying new machines to produce more goods. This spending is an investment that adds to the economy's productive capabilities. Investment can be categorized into:

• Business investments: Spending on new equipment and infrastructure.
• Residential investment: Construction of new homes and apartments.
• Inventories: Stocks of goods held back for future sales.

In our scenario, investment is valued at $700 billion, indicating a commitment to future growth.

Government Spending in GDP

Government spending is the total expenditure by the government on goods and services. It includes spending on public services such as education, defense, and infrastructure, which all contribute to the economy's overall performance.

This component is important because government actions like building roads or funding schools can boost economic activity. Consider government purchasing new fighter jets or building highways. Such purchases inject money directly into the economy.

• Federal spending: National defense, social security, and administrative functions.
• State and local spending: Infrastructure, education, and public safety.

In the given example, government purchases amount to $1200 billion, emphasizing the government's active role in supporting the economy.

Net Exports in GDP

Net exports are calculated as the total value of a country's exports minus its imports. This figure reflects a country's trade balance, measuring whether it sells more to the world than it buys.

If exports exceed imports, the country has a trade surplus; if imports are higher, there's a trade deficit. This balance can impact GDP either positively or negatively. In our example, export spending is $100 billion, while import spending is $150 billion, resulting in net exports of -$50 billion.

This negative balance means there is a trade deficit, showing the country is importing more than it exports, which slightly decreases overall GDP. Understanding net exports helps in grasping the global interaction of an economy. It reflects how competitive a nation is in the global market and influences the currency's strength. Changes in net exports can indicate shifts in consumer preferences or economic conditions worldwide.