Describe each of the variables in the GDP equation in detail - how does each one affect total GDP?
The most common equation used to find gross domestic product (GDP) is the equation for what is called the expenditure approach. The equation is generally given as
GDP = C + I + G + (X – M)
In this equation, C stands for consumer spending, I stands for investment spending, G stands for government spending, X stands for exports and M stands for imports. Consumer spending, investment spending, government spending, and exports all add to GDP. Imports, by contrast, reduce GDP.
Consumer spending is the largest component of GDP in the United States. It typically accounts for over two-thirds of GDP. This is money that households have paid to buy goods and services.
Investment spending is also called gross private domestic investment. This consists of two things. First it consists of payments for capital goods. When a firm buys new machines, they count as part of I in this equation. Second, there is the change in inventory that firms have. These are goods that have been produced in a given year but have not yet been sold.
G is government spending. This includes purchases the government makes of goods and services. It does not include transfer payments like welfare or Social Security since those are not being paid for work being done in the current year.
Finally, there are exports, which are made in a country and sold abroad and imports, which are goods made abroad and sold within (in this example) the US.