Gross domestic product, the total value of goods and services produced within the United States minus the value of goods and services, or inputs, used in production, can be measured three different ways: 1) expenditures approach, 2) income approach, and 3) production approach.
The most well-known method for computing GDP is the expenditures approach, the sum of all domestically produced goods and services sold to final users1. This approach uses the formula found in economic textbooks “C+I+G+X-M” to calculate GDP:
- C is the value of goods and services sold to people.
- I is the value of business investment.
- G is the value of goods and services sold to the government.
- X is the value of goods and services the United States exported, or sold, abroad.
- M is the value of goods and services the United States imported, or purchased, from abroad. ‘M’ is subtracted from the sum of C, I, G, and X to ensure that GDP measures only the value of domestically produced goods and services.
As the name suggests, the expenditures approach is a demand-based approach. Personal consumption (C), business investment (I), government expenditures (G), and exports (X) all include expenditures on both domestically produced and imported goods and services.
For most final expenditure components, it is not possible to distinguish between expenditures on domestically produced and imported goods and services. For example, personal consumption of goods is based on retail sales data, which do not distinguish between sales of domestically produced goods versus imported goods. Similarly, inventory investment is based on inventory data which also does not distinguish between domestically produced and imported goods. Therefore, to avoid including foreign production in GDP it is necessary to subtract the value of imports from the measure of domestic expenditures.
All of this makes decomposing sources of change in GDP using the expenditures approach a bit challenging. For example, suppose inventory investment is the leading contributor to an increase in GDP, but that increase is all from imported goods. Is it accurate to attribute the increase in GDP to inventory investment? Conceptually, we know imports do not contribute to GDP. However, within this framework, where expenditures on domestically produced and imported goods and services are commingled, it is the only way to decompose changes in GDP.
However, as more data become available through the GDP estimation cycle, we’re able to augment the expenditures approach with two additional approaches that provide new ways to analyze GDP and the economy. For example, the income approach (typically available with the second GDP release) provides insights on the contributions of labor and capital. This measure is referred to as gross domestic income and is calculated as the sum of incomes earned (e.g. corporate profits, wages, etc.) and costs incurred in the production of GDP. With the third GDP estimate, we’re able to calculate GDP using the production approach in a fully integrated input-output accounts framework. The production approach features GDP by industry, derived as gross output minus intermediate inputs. This perspective is particularly useful for decomposing sources of GDP growth (or contractions) by producing industry. With all three measures in hand, data users can more fully analyze the health of the U.S. economy.
1 This is the only method that BEA can use to compute GDP for an “advance” estimate, which is published approximately 30 days after the quarter ends. The other two approaches require data that are not available in time for an advance estimate.