Part 2: GDP Components – Consumption, Investment, Government, and Trade
See Part 1 of this Webinar Here: Part 1: USA – The World’s Largest Economy, Some Figures and Stats, the Debt & the Budget Debate
See Part 3 of this Webinar Here: Part 3: Key US Macro Indicators
1. GDP = C + I + G + (X-M)
- C = Consumption (personal consumption expenditures or PCE)
– Durable goods, non-durable goods, services - I = Investment
–Business investment, residential construction, changes in inventories - G = Government Spending
- (X-M) = Exports – Imports
The 4 components of GDP are consumption, investment, government spending and trade.
Consumption (C)
The consumption of goods and services falls under one of the following categories:
- Durable goods – Durable goods are those goods designed to last more than 3 years, something that is durable and long lasting. It can almost be considered an investment by a household. Examples of durable consumer purchases include washing machines, refrigerators, automobiles, and toaster ovens.
- Nondurable goods – In contrast to durable goods, nondurable items have a shorter life span. An example of a nondurable consumer purchase is groceries. The life span of the typical food is short, especially compared with the refrigerator (durable item) in which perishable foods are kept. Other examples of purchases that are considered non-durables include newspapers, magazines, clothing, and hats (which are always flying off with the wind).
- Services – Spending on services make up the largest part of consumption. The services sector consists of many sectors including real estate, finance and insurance, entertainment and arts, technical and scientific professionals, the legal field, and others. Spending on services makes up the largest part of consumption.
Some Questions on Consumption:
We often hear that “consumer spending” makes up 70% of GDP, which is slightly misleading. While its true that Consumption makes up 70% of GDP, its not all just people shopping at stores for new goods. Health services are a big part of overall consumption, and government spending on health care is factored into the equation.
Also, if Americans are consuming more but the goods that they are buying are imports from abroad, then part of the money being spent is being sent out of the country and will count as a negative to GDP. Therefore the strong focus on consumption over production might not be the most reliable indicator of economic help. A dollar of consumer spending does not translate into a dollar of domestic production.
However, in the long run, consumer spending is a more reliable indicator of economic health than production, because spending, not production touches virtually every household. Consumer spending translates into sales, which, of course, translate into shipping, warehouse space, retail space, accounting, etc., all types of economic activity that boosts the economy, regardless of whether the product involved is imported or domestically manufactured.
It does therefore make sense to look at spending in general rather than just on production when assessing the macro picture of an economy, but its good as an analyst to sort out the individual industries to know what’s going on in each sector and how much to weigh our various fundamental indicators.
Investment (I)
Businesses and corporations undertake investment activity that involves the purchase of goods which themselves assist in the production process. The categories of investment are:
- Business Investment – This includes the actual purchases of goods used in the production process. Business investment includes the construction of new offices and factories, and the purchase of machinery, computers, and any other equipment used to assist labor in the production of goods and services.Business investment counts as gross investment, which includes purchases of machinery to replace worn-out equipment. If a firm replaces one machine with another that does not increase output, then nothing is added to the nation’s economy. To correct for this, net investment can be used, which subtracts out depreciation of existing capital from the gross (total) business investment made by firms.
- Residential Construction – This part of overall investment tracks the actual construction of housing, not the sale of homes. A new home that is built during a given year is counted in that year’s GDP, while the purchase of a previously owned house has already been counted in the GDP of the year it was constructed. In this way, only those residences that add to the overall housing stock count towards GDP.
- Changes in inventories – Firms invest in inventories, which are produced goods held in storage in anticipation of later sales. Firms also stockpile raw materials and intermediate goods used in the production process. Goods held in inventories are counted for the year produced, not the year sold.Although inventories are a relatively small portion of the overall investment sector, inventories are a critical component of changes in GDP over the business cycle. If the economy is slowing down, possibly entering a recession, the bearer of the bad news will often be an undesired accumulation of inventories. As consumers reduce their purchases, sales of goods and services slow, inventories build up, and firms slash production (laying off employees) to reduce unwanted (and costly) inventories.
Government Spending (G)
The government sector tracks what the government actually spends money on. Government purchases of goods and services include stealth bombers, government-funded research, space shuttles, salaries, and toasters. Many of these items are seldom sold in markets; as a result, they are valued at the price the government pays for them. The calculation of government spending for GDP purposes excludes several tremendous categories of actual spending: transfer payments, which redistribute income primarily to individuals who are potential consumers, and interest payments on the debt.
Net Exports (X-M)
Net exports is the difference between a country’s exports and imports. The US exports less than it imports, so it runs a trade deficit and overall, trade takes away from GDP.
2. Each Component as Percentage of GDP
What percentage does each component make up of US GDP? Here is a breakdown in percentage terms.
- C = Real PCE = 70.8% of GDP
- I = Nonresidential Fixed Investment (9.8%)
- X = Net Exports (-3.3%)
Exports (12.9%) –Imports (16.2%) - G = Government Spending = 20.4%
3. How Big is Each Component in Actual Dollar Terms?
And a breakdown in actual dollar terms using the latest statistics for GDP in the 4th quarter of 2010.
4. Breaking Down GDP by Sectors
Here is a breakdown of the different sectors within Personal Consumption Expenditures:
- Personal consumption expenditures is made up of good and services.
- Services (68.7%)
–Real estate and rental (13% of GDP)
–Finance, insurance (8.3%)
–Health care (7.5%) –Professional and business services (legal, computer, science/technical) (12%)
–Retail (5.8%), wholesales trade (5.5%) - Goods Producing (17.7% )
–Manufacturing
•Non-durable Goods (5.1%) •Durable Goods (6.1%)
–Mining (1.7%), Utilities (1.9%), Agriculture (0.9%)
5. Employment by Sector
Here is a breakdown of how many workers are employed in each sector. It’s interesting to not the difference between the importance to GDP when comparing to the importance of how many jobs depend on a particular industry or sector.
- Services (90.2M)
–Real estate and rental (1.9M)
–Finance, insurance (5.6M)
–Health care (16.5M) –Professional and business services (16.9M)
–Retail (14.4 M), wholesales trade (5.4M)
–Education (3.1M) - Goods Producing (17.8M)
–Manufacturing
•Non-durable Goods (4.4M)
•Durable Goods (7.1M)
–Mining (732K), Utilities (549K), Agriculture (0.9%)
–Construction (5.45M) - Government (22.2 M)
6. Key Indicators to Use to Gauge Consumption
- Key Indicators:
- Retail sales
- Personal spending
- Factory orders, durable goods orders
- Motor vehicle sales, home sales
- Consumer confidence
We examine all our key indicators for the US economy in Part 3.
See Part 1 of this Webinar Here: Part 1: USA – The World’s Largest Economy, Some Figures and Stats, the Debt & the Budget Debate
See Part 3 of this Webinar Here: Part 3: Key US Macro Indicators
