Today we're going to talk about

how to count the total value

of all production in the economy,

the total value of all income in the economy,

and the total value of all the expenditure

in the economy.

The good news they're all the same number.

That number is gross domestic product or GDP.

Let's look at the total production

of Laurasia,

a small country.

One year they produced 200 t-shirts,

400 apples, and 50 hammers.

Yeah, I told you they are small.

Is that a good amount of production?

It sort of depends on how valuable you think

t-shirts, apples, and hammers are

but I'll make the question more specific.

Following year Laurasia produced

200 t-shirts, 300 apples, and 80 hammers.

The production of one good stayed the same,

another fell and another rose.

So what happened to the

overall value of output?

Now we really need an impartial way

to put relative values

on these different goods.

Economists argue

that the best common denominator value

for a product

is its market price.

Looking at Laurasia

we find that t-shirts are $15,

apples are $0.50

and hammers are $25 dollars.

So now we can say

that in the first year

Laurasia produced $3,000 worth of t-shirts,

$200 worth of apples,

and $1,250 worth of hammers.

That comes to a total value of production

of $4,450.

Using the same prices

we can see that the following year

Laurasia produced

$3,000 worth of t-shirts again,

$150 worth of apples

and $2,000 worth of hammers.

That comes in to a total of $5,150.

So GDP in Laurasia

increased from one year to the next

but we couldn't have seen that

just from looking at the

quantities produced.

We had to weight those quantities

using their market prices.

That's the output method

of calculating GDP.

Now let's look at the income method.

That method adds up all the income earned

by all the people in the country.

This income falls into

a couple of different categories.

The biggest is typically compensation

for employees.

This counts wages and salaries

as well as payments

for health and retirement benefits.

The next category of income

is called proprietors income.

This is income earned

by self-employed business owners.

The next category is called rental income.

As you might expect

this is income earned by property owners

from renting their property to others.

The last category is corporate profits.

This one is a little tricky

because at first it may seem like

no actual people get that money.

However, after paying employee compensation,

business expenses, interest payments,

and corporate taxes,

corporations have two options

with what's left over.

They can return the remaining profits

to their shareholders

in the form of dividends,

or they can retain those earnings

to fund investments in capital

in which case the shareholders

see the value of their stock rise.

Either way human beings,

the shareholders get that money.

The main takeaway is that

all these types of income add up to GDP.

The idea is that for every unit of output

produced and sold,

somebody earns that money

whether it says wages, rent,

or return on capital.

Finally we can count GDP

using expenditures.

We break expenditures into categories

not based on what is being purchased

but by who is doing the purchasing.

You may be familiar

with these categories already.

Expenditures by individuals in households

are called consumption.

Expenditures by businesses for capital

although not for raw materials or labor

are called investment,

and expenditures by governments

at the national state or local level

are called government purchases.

Note that when governments

purchase a vehicle

or hire a teacher or a judge

that counts as a government purchase.

However, payments from programs

like Social Security or Medicare

are not counted as government purchases,

because at least in these examples

they are counted in consumption

when seniors use those payments

to buy products or healthcare services.

Expenditures by foreign citizens

on domestically produced goods

are called exports.

While expenditures by domestic individuals

on foreign produced goods are called imports.

In the GDP equation

we subtract imports from exports

to give a concept called net exports.

And as you'll recall

consumption plus investment

plus government purchases

plus net exports add up to GDP,

and this sum of expenditures

is also equal to the sum of all income

earned in the economy

which is also equal

to the sum of all production

in the economy.