International Finance Theory and Policy
by Steven M. Suranovic

Finance 5-2

The National Income or Product Identity

The national income or product identity describes the way in which GDP is measured; as the sum of expenditures in various broad spending categories. The identity, shown below, says that GDP is the sum of personal consumption expenditures (C), private investment expenditures (I), government consumption expenditures (G), expenditures on exports (EX), minus expenditures on imports.

GDP = C + I + G + EX - IM

Personal consumption expenditures (C) (consumption for short) includes goods and services purchased by domestic residents. These are further subdivided into durable goods, commodities that can be stored and that have an average life of at least 3 years; nondurable goods, all other commodities that can be stored; and services, commodities that cannot be stored and are consumed at the place and time of purchase. Consumption also includes foreign goods and services purchased by domestic households.

Private domestic investment (I), (investment for short) includes expenditures by businesses on fixed investment and any changes in business inventories. Fixed investment, both residential and non-residential consists of expenditures on commodities that will be used in a production process for more than 1 year. It covers all investment by private businesses and by nonprofit institutions, regardless of whether the investment is owned by domestic residents. Nonresidential investment includes new construction, business purchases of new machinery, equipment, furniture, and vehicles from other domestic firms and from the rest of the world. Residential investment consists of private structures, improvements to existing units, and mobile homes.

Government expenditures includes purchases of goods, services, and structures from domestic firms and from the rest of the world by federal, state and local government. This category includes compensation paid to government employees, tuition payments for higher education and charges for medical care. Transfer payments, such as social insurance payments, government medical insurance payments, subsidies and government aid are NOT included as a part of government expenditures.

Exports consists of goods and services that are sold to non-residents.

Imports includes goods and services purchased from the rest of the world.

The difference between exports and imports, EX - IM, is often referred to as net exports. Receipts and payments of factor income and transfer payments to the rest of the world (net) are excluded from net exports.

International Finance Theory and Policy - Chapter 5-2: Last Updated on 5/21/98