Expenditure approach to calculating GDP examples | AP Macroeconomics | Khan Academy

What I hope to do in this video is provide even more examples to make sure we really understand how various things would be accounted for in the expenditure approach to GDP. Now, we have talked about this in other videos. There are many different ways of calculating GDP, but in the expenditure approach, you can break it down as being made up of consumption by households, plus investment by firms, plus government spending on goods and services by the government, and net exports.

So, with that out of the way, pause this video and look at each of these statements. Think about what effect it would have on GDP if we use the expenditure approach and how it would be accounted for in these various categories.

Okay, now let's work through this together. So, this first scenario says Ford pays 1 million dollars for a US-made robot for its factory in California. We have a firm right here; it is Ford, and it's investing in physical capital. In most cases, especially if you're looking at some type of a standardized test, on an AP exam, investment is firms investing in physical capital, although it can also be in intellectual capital—things like software. But this is very clear; it's Ford buying a US-made robot, physical capital. This robot is going to help Ford make more cars or trucks, whatever it's trying to make.

So, this is very clear that it would increase GDP. GDP would go up by one million dollars because of this one million dollars, and the place that it would be accounted for is in investment. I could say investment would go up one million dollars. The reason why GDP goes up one million dollars, or you would add one million dollars to GDP, is because you would add one million dollars to investment. This is a clear investment by a US firm.

Now let's look at the next scenario. A US car rental company spends 1 million dollars to buy 30 new Fords that were made in the US. So, pause this video again; see if you can think of that. Well, this is a very similar scenario: a US car rental company, and it is investing in physical capital right here by buying those 30 new Fords. It can rent those out to create future benefit. Once again, it would be the same thing as in that first case; GDP would go up by a million because investment goes up by a million.

In this case, as well, GDP would go up by a million dollars because investment went up by a million dollars. Now let's look at this third scenario. A US car rental company spends 1 million dollars to buy 30 new Toyotas that were made in Japan. So, how is this different? Well, in this scenario, you still have a US firm investing in physical capital, spending a million dollars. So, you would actually have investment go up by one million dollars, but it's not investing in things that are made in the United States; it's investing in things that are made in Japan.

So, in this particular scenario, it will be counteracted by net exports. Here we are importing a million dollars worth of things, and so that would take net exports down. Net exports would go down by one million dollars. A one million dollar import is the same thing as a negative one million dollar net export. Because of these two factors, this will have no impact on GDP—no impact on GDP.

The reason why this makes intuitive sense is that GDP is supposed to measure how much was produced, and in this scenario, a car rental company is investing, but it was produced someplace else; it wasn't produced in the United States.

Now, this next scenario: a Japanese car rental company spends one million dollars to buy 30 new Fords that were made in the United States. This is almost a symmetrically opposite scenario. We would not add to investment here because this is a Japanese car rental company, and we're calculating GDP for the United States—or at least that's the assumption. But because the U.S. would export these 30 new Fords, worth 4 million dollars, that would add to net exports.

So, in this case, net exports—let me do the net export color—net exports would go up by 1 million dollars. Because net exports went up by 1 million dollars and nothing else here is impacted, GDP would go up by one million dollars. Once again, the reason why this makes sense is that the United States produced one million dollars worth of stuff; it happened to export them out, and that's where it got accounted for.

Definitely, GDP is one million dollars higher because of this.

So, this next one is interesting: you buy a hundred thousand dollars of IBM stock. What do you think this is? Pause this video again. In traditional language, you might say, "I invested a hundred thousand dollars in IBM stock," but I'm a household. So, how does this work? Well, it turns out that this does not move any of these dials right over here because, at least the assumption here is that you are buying that hundred thousand dollars of IBM stock from someone else.

It is not because something is being made in the United States, and there is some new productivity that's happening. Even though in everyday language we sometimes think of this as an investment, this has no impact on any of these categories. So, no impact. I really want to emphasize that investment is sometimes associated with things like buying stocks, but investment in the GDP sense is when a firm is buying some type of capital that will give it some future benefit, help it make things better. Oftentimes it's physical capital; more and more it's often things like software or some type of intellectual capital.

Microsoft buys 100 million dollars of IBM stock. This one might be even more tempting to put in the investment category because Microsoft for sure is a firm, and it looks like it's investing in another firm. But once again, Microsoft isn't buying some type of physical machinery or it isn't buying an accounting system or some type of intellectual capital; it's just buying shares from someone else. So, once again, nothing new is being produced in the country, so this has no impact. I really want to emphasize these last two because this shows up on some exams where it says, "Oh, this kind of feels like an investment," at least in everyday language.

So, people would account for it there, but remember no new capital; Microsoft isn't buying something that's going to help Microsoft produce more of whatever Microsoft is trying to produce.

All right, this next one: the Social Security Administration makes a two thousand dollar payment to a retiree. What do you think is going on there? You might be tempted to say, "Hey, that's a government expenditure; the Social Security Administration is spending two thousand dollars." But we have to remind ourselves that this G category is government expenditure on goods and services, not a transfer payment like this. So, this would have no impact.

Another intuitive way to think about it—and we've been talking about this for a while—is that nothing new is being produced in the United States because of this payment. Now, we can contrast that with the next scenario right over here: the Social Security Administration buys a new accounting system.

Well, in this scenario, the government is buying a good or service. It might be a combination of both; they might have to buy some computers, some software, maybe hire some consultants to implement it for them. So, it is the government paying for goods and services. In this situation, our government category would go up by however much they're spending. Let's say they spent, I don't know, one million dollars again. So then the government category would go up by one million dollars because it's a goods or services spending, and because of that, GDP would go up by one million dollars.

Hopefully, you enjoyed that.