📊 What Is GDP?
Definition: Gross Domestic Product (GDP).
Key words in the definition
- Final goods and services — to avoid double counting (don't count flour AND bread).
- Within a country's borders — GDP measures domestic output regardless of who owns the factors.
- Time period — GDP is a flow variable (measured over time), not a stock.
GDP vs GNI: GDP measures output produced inside the country. GNI measures income earned by a country's citizens, wherever they work.
🔢 Three Approaches to Measuring GDP
All three methods should give the same result because they measure the same circular flow from different angles:
1. Output (production) approach
Add up the value added at each stage of production across all industries. Value added = output − intermediate inputs.
2. Income approach
Add up all incomes earned in production: wages + rent + interest + profits. Every dollar of output generates a dollar of income for someone.
3. Expenditure approach
Add up all spending on final output:
The GDP formula: GDP = C + I + G + (X − M)
Where: C = consumption, I = investment, G = government spending, (X − M) = net exports.
The expenditure approach is the one you'll use most in IB. Memorise C + I + G + (X − M) — it's the foundation for understanding aggregate demand.
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🔄 The Circular Flow of Income
The circular flow model shows how money moves between households (who supply factors of production) and firms (who produce goods and services). It illustrates why the three approaches give the same GDP.
Injections and leakages
- Injections.
- Leakages (withdrawals).
Equilibrium condition: The economy is in equilibrium when total injections = total leakages: I + G + X = S + T + M. If injections > leakages, national income rises. If leakages > injections, it falls.
You should be able to draw a simple circular flow diagram showing the flows between households and firms, with injections entering and leakages leaving the flow.