GDP is generally understood to represent the health of a nation’s economy, and most people realize that if GDP is growing, things are going well, while if it’s falling things have turned sour in the economy. But what, precisely, does GDP measures? There are two primary methods for measuring GDP, which should yield the same result even though they measure completely different factors.
- The income approach: measures the total incomes earned by households in a nation in a year.
- The expenditure approach: measures the total amount spent on the goods produced by a country in a year.
By examining the circular flow model of a nation’s economy, we can demonstrate why every dollar earned by a household in a nation’s resource market will ultimately be spent in the product market, or leaked through taxes, savings, and import spending, leading to injections in the form of government spending, investment and export sales.
In the video lecture below, the two methods for measuring GDP are introduced, and the various components it includes are explained in detail. Watch the video and then download and attempt the activity: