Why do we subtract imports in the GDP formula?

We subtract imports because the $C$, $I$, and $G$ components include money spent on foreign goods. Since GDP only measures what is produced domestically, we have to subtract those imported goods back out.

Does buying stocks count as Investment ($I$)?

No. In economics, investment refers to businesses purchasing physical capital, like machinery or new buildings, or changes in inventory. Buying stocks is a financial transaction, not the creation of new goods.

Are government transfer payments like Social Security included?

No. Transfer payments are just moving money from one group to another without any new good or service being produced in exchange. They are not included in $G$.

What is GDP and how is it measured?

Gross Domestic Product (GDP) is the total market value of all final goods and services produced within a country's borders in a specific time period. Think of it as the price tag on a nation's total economic output for a year. If a country were a giant bakery, GDP wouldn't measure the flour and sugar bought by the baker. It measures the final cakes and breads sold to customers. This keeps us from counting the same ingredients twice.

The Expenditure Approach

The most common way to calculate GDP is by adding up all the money spent on final goods and services. The formula is $GDP = C + I + G + (X - M)$ . $C$ stands for Consumer spending, like buying a new phone. $I$ is Investment by businesses, like buying factory equipment. $G$ is Government spending on things like roads and schools. Finally, $(X - M)$ represents net exports, or exports minus imports.

What gets left out?

GDP only counts final goods. If a car manufacturer buys tires to put on a new car, the tires are intermediate goods and aren't counted directly. Only the final sale of the car is counted. GDP also ignores non-market transactions. If you pay someone to mow your lawn, it counts. If you mow it yourself, it doesn't. Used goods are also excluded, because they were already counted in the year they were originally produced.

Real vs. Nominal GDP

A common place students slip up is confusing Nominal GDP with Real GDP. Nominal GDP is measured using current prices. If prices go up due to inflation, Nominal GDP goes up even if the country didn't actually produce more goods. Real GDP is adjusted for inflation. It uses the prices from a fixed base year. This gives a much more accurate picture of whether an economy is truly growing or just experiencing rising prices.

Worked through

Calculate the GDP for a hypothetical country using the following data: Consumer spending = $500, Business investment =$ 150, Government spending = $200, Exports =$ 100, Imports = $120.

We use the expenditure approach formula: $GDP = C + I + G + (X - M)$ . First, identify the values: $C = 500$ , $I = 150$ , $G = 200$ , $X = 100$ , $M = 120$ . Next, calculate Net Exports $(X - M)$ , which is $100 - 120 = -20$ . Now, add everything together: $GDP = 500 + 150 + 200 + (-20) = 830$ . The GDP of this country is $830.

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Where this comes from: OpenStax Principles of Macroeconomics, Chapter: The Macroeconomic Perspective · Khan Academy Macroeconomics, Unit: National income and price determination