Study Note - Introduction to GDP

Gross domestic product (GDP) is the total value of output in the UK and is used to measure change in economic activity GDP includes the output of foreign owned businesses that are located in the UK following foreign direct investment. For example, the output produced at the Nissan car plant on Tyne and Wear and by foreign owned restaurants and banks all contribute to the UK’s GDP.

National Output = National Expenditure (Aggregate Demand) = National Income

(i) The Expenditure Method - aggregate demand (AD)

The full equation for GDP using this approach is GDP = C + I + G + (X-M) where
C: Household spending
I: Capital Investment spending
G: Government spending
X: Exports of Goods and Services
M: Imports of Goods and Services

The Income Method – adding factor incomes

Here GDP is the sum of the incomes earned through the production of goods and services. This is:

Income from people in jobs and in self-employment + Profits of private sector businesses
+ Rent income from the ownership of land
= Gross Domestic product (by factor incomes)

Only those incomes that are come from the production of goods and services are included in the calculation of GDP by the income approach. We exclude:

• Transfer payments e.g. the state pension; income support for families on low incomes; the Jobseekers’ Allowance for the unemployed and welfare assistance such housing benefit.
• Private transfers of money from one individual to another
• Income not registered with the Inland Revenue or Customs and Excise. Every year, billions of pounds worth of activity is not declared to the tax authorities. This is known as the shadow economy or black economy. According to a World Bank report published in October 2010, the average size of the shadow economy (as a percentage of "official" gross domestic product) in Sub-Saharan Africa is 38.4 percent; in Europe and Central Asia (mostly transition countries), it is 36.5 percent, and in high-income OECD countries, it is 13.5 percent.

Published figures for GDP by factor incomes will be inaccurate because much activity is not officially recorded – including subsistence farming, barter transactions and the share economy mentioned above.