Components of GDP

Economists divide the statistics on GDP into four major categories of expenditures. These are:

  1. consumption,
  2. investment,
  3. government and
  4. net exports expenditures.
These categories are used by economists to explain why GDP fluctuates and to forecast future GDP.

1.   Personal Consumption Expenditures, or ‘Consumption

Consumption is the spending by households on goods and services, not including spending on new houses.

Consumption expenditures are made by households and are divided into:

  • expenditures on services, such as medical care, education and haircuts;
  • expenditures on non-durable goods, such as food and clothing; and
  • expenditures on durable goods, such as cars and furniture.

The spending by households on new houses is not included in consumption. Instead, spending on new houses is included in the investment category, which we discuss next.

2.   Gross Private Domestic Investment, or ‘Investment

Investment is the spending by firms on new factories, office buildings, machinery and inventories, plus spending by households on new houses.

Spending on gross private domestic investment, or simply investment, is divided into three categories:

Inventories are goods that have been produced but not yet sold.

If a car manufacturer has $20 million worth of unsold cars at the beginning of the year and $35 million worth of unsold cars at the end of the year, then the firm has spent $15 million on inventory investment during the year.

3.   Government Consumption and Gross Investment, or ‘Government Purchases

Government purchases are spending by federal, state and local governments on goods and services, such as education, roads and aircraft carriers.

Again, government spending on transfer payments is not included in government purchases because it does not result in the production of new goods and services.

4.   Net Exports of Goods and Services, or ‘Net Exports

Net exports is equal to the expenditure on exports minus the expenditure on imports.

Exports are goods and services produced in the country (i.e. Australia), but purchased by foreign firms, households and governments.

We add exports to our other categories of expenditures because otherwise we would not be including all spending on new goods and services produced in Australia.

For example, if Australian universities receive $10 billion in fees from overseas students, those exports are included in GDP because they represent production in Australia.

Imports are goods and services produced in foreign countries, and purchased by Australian firms, households and governments.

We subtract imports from total expenditure, because otherwise we would be including spending that does not result in production of new goods and services in Australia.

For example, if Australian consumers buy $1 billion worth of furniture manufactured in Indonesia, that spending is included in consumption expenditure.

But the value of those imports is subtracted from GDP because the imports do not represent production in Australia.

An Equation for GDP and Some Actual Values

A simple equation sums up the components of GDP:

The equation tells us that GDP (denoted as Y) equals consumption (C) plus investment (I) plus government purchases (G) plus net exports (NX).

Figure I shows the values of the components of GDP for the financial year 2008.

Figure I, Graph of Components of GDP Figure I, Graph of Components of GDP

The graph in the figure highlights the fact that consumption is by far the largest component of GDP.

Consumption accounts for almost 55 per cent of GDP, far more than any of the other components.

In recent years, net exports typically have been negative, which reduces GDP.