 Hello and welcome to the session in which we'll discuss the concept of gross domestic product or known as GDP. So what is GDP? Well, it's an economic measure, basically a measuring stick, a way to measure. What are we measuring? We're measuring the economic condition of a country, how well or not well a country is doing. Well, we need to figure out, put a number on that. Well, GDP is that number. Now, how do we compute GDP? We're going to see there are various ways in computing GDP, nevertheless, it's a measurement stick. How well or not well a country doing. And we know how well we are doing from year to year, because if we are using the same measurement, we can compare how well we did this year versus last year. Also, if we are comparing our GDP in the US, then we can compare our GDP to Canada. So it's a measuring stick and will help us compare the GDP in certain countries. What is usually GDP? How is it usually measured? It's the value of all goods and services within a country's border in a specific period usually here. So what's important about this is this GDP deals with territorial measurement. So when I say GDP, I'm measuring GDP inside the United States. This include everything produced by all individuals and company within the United States. So within the United States, we could have Canadian companies. Those are part of the US GDP. We could have Mexican countries, Mexican companies. That's part of our GDP hours means the US GDP. We could have Chinese companies, we could have European companies. When we measure the US GDPs, everything that's produced, all goods and services produced within the United States is part of GDP. Now why do we have to learn about GDP? And specifically for the CPA exam, why do we have to learn about this? Well, businesses don't function in vacuum. So if a business, a business function within an industry, each business belong to an industry, and the industry belong to the whole economy. So if we are performing analytical procedures, if we are auditing a company, part of auditing the company is perform analytical procedures. We have to know how well we have to understand how well the economy is doing overall, how well the industry is doing in order to understand how well the company that we are dealing with is doing. So that's why it's important that we learn economics and specifically GDP. So GDP, we use this term when we are discussing business cycles, inflation, physical and monetary policy and many other economic terms. So it's very important to understand what does it represent? Well, if you want to summarize it, it's a measuring stick. It's a way to measure, gives you insight about the economic condition of a country. This way, if your company is not doing well, you might say, well, it's because GDP, the overall GDP is going down. Well, that's why I'm not doing well. That could be an explanation. But if we don't understand what GDP is, then we cannot put things into perspective. Now, let's go ahead and see how GDP can be computed because there are more than one way to compute GDP. Before we proceed any further, I have a public announcement about my company, farhatlectures.com. That accounting lectures is a supplemental educational tool that's going to help you with your CPA exam preparation, as well as your accounting courses. My CPA material is aligned with your CPA review course, such as Becker, Roger, Wiley, Gleam, Miles. My accounting courses are aligned with your accounting courses, broken down by chapter and topics. My resources consist of lectures, multiple choice questions, true-false questions, as well as exercises. Go ahead. Start your free trial today. There are three ways to compute GDP, gross domestic product. And we're going to do this in a simple way. The three ways are the production method or the production approach or the output approach, the income approach, and the expenditure approach. Now bear in mind, this is not an econ course. I'm teaching this for accounting students. So all what needs to be done here is basically understand how each approach works. I'll give you a very simple example and we could move on. Now, this definitely, if you're taking an econ course, it might help, but I am not teaching it to econ students. Starting with the production output approach, which is one of two approach, this approach is calculated by adding all what we call the value added at each stage of the production to arrive to the total. So we're adding up, what are we adding value to the process to arrive to the total? The value added is the difference between the cost of input into the production process and the resulting output. Well, because we want to have more output than input, we want to keep more. And the formula could be expressed as follow the gross value of the output minus the value of intermediate consumption. Now, what does that all mean? Let's take a look at a simple example to illustrate this formula. So let's assume, let's consider we are, you know, it's a simple economy. We have a single manufacturer. Now we could have many, we could have millions, but just to illustrate the point, we have a baker and we have the consumers. And suppose there's only one type of bread that's being produced using flour. So we have the farmer. The farmer will grow the wheat and sells it to the miller. Suppose the farmer sells the wheat for a dollar. This is the first value added to the product. Now we have the wheat, it's a dollar, and we assume it costs the farmer zero. So one minus zero equal to a dollar, which is not true, but to make the point. Now the miller buys the wheat, grinds it into flour and sells the flour to the baker. Suppose the miller sells it for two dollars. Now remember, the miller paid a dollar, therefore the value added here is also a dollar. So we have one dollar added from the farmer, one dollar added from the miller. Now we have the baker. Remember now the floor is with the baker. The baker buys the flour, not the floor of the flour, bakes bread and sells the loaves to the consumers. And suppose they sold it for three fifty. What is the value added? Well the value added to this process is three fifty minus the two dollars because they bought it for two. So the value added is dollar fifty. So if we are computing GDP in this simple economy, well it's a dollar, the farmer's output, the dollar, the miller's value added and dollar fifty, the baker value added, all in all the GDP is three point five. So notice we did not double count. For example we did not count one plus two plus three point five plus three point five. We only added the value added, the value added. So this is the production or output approach. Another way to measure the GDP is to measure it from an income approach. Simply put, adding up all the incomes in the economy, wages, interest, profit, rent, how much income? Think about it. Think of if I'm measuring your economic health from your income. So the GDP is computed by looking at compensation of employees, which is wages, rental and royalty income, business cash flow, business income, net interest minus subsidies because the subsidies are given by the government. Let's take a look at the income approach. If we're measuring the GDP from an income approach, how would we measure GDP? Well let's imagine also another simplified economy that consists of only three businesses and their workers. That's the only thing in the economy. So we have business A. In this business the workers earned half a million dollar in wages and the owners of the business also earned 300,000. So notice in total the business earned 800,000. They paid wages to the employee of 500K and the owner kept in profit 300K. We have business B. In this business the workers earned 400,000 dollar in wages and the business did not make any profit. What does that mean? It means all the profit that was produced in the business went in wages. For the business because it's a separate entity from the workers, of course it is, did not earn anything and the business is represented by the owners. They didn't earn anything. Therefore the total in wages is 400,000. So we have 400,000 in wages income. We have business C. Now remember we could have millions of businesses but just to make the point. In this business workers earned a total of 100,000 dollar in wages. However, the owners did very well and earned 500,000. So here we have wages to the workers and we have profit, profit of the business. Now the GDP under the income approach is what is that? It's the wages, what the employee earned plus what the businesses earned because we only have businesses, we only have employees and we're not assuming there's rent, we're not assuming other form of income just to give this example simple. Therefore how do we compute GDP? We have half a million in income, half a million in wages, 400,000 in wages and 100,000 dollar in wages. So those are the wages for business A, B and C. Then we have 300,000 in profit for business A and half a million in profit for business C. Together this GDP is 1 million in wages, 800 in total profit. We say that the GDP is 1.8 million. Now we can next year we can go ahead and compute the GDP again using the income approach to determine whether as a whole country, as a whole country, did we improve our GDP or not? Again, this is a simplified version of a more comprehensive calculation would also include rent, interest income as well as taxes minus subsidies because remember we collect taxes then if we provide subsidies then it's a form of giving back from the government. We're just simplifying this. So we are left all these components for clarity and for simplicity. The third approach is the expenditure approach and this is the most common method of computing GDP. If anything you might have to know a little bit about the expenditure approach. What is the expenditure approach? What we're going to do now to measure GDP, we're going to take all the spending, add up all the spending of the economy which is consumption by the consumer, investment by businesses, government spending and net export. What's net export? It's what you export minus your import. So if you're exporting 100 and importing 30, you have a net export of 70. It means you are selling more to the outside world and the opposite is true. If you're exporting 30 and you're importing 70, you are negative 40. So it's a negative. So that's why we mean by net export it could be positive. It could be negative. If you are selling it's positive. If you are bringing in it's negative. So usually consumption is represented by C, investment by I, government spending G, X minus M, export minus import M is import and X for export. So in simple terms, I'd calculate the money spent by the different groups that make the economy. That's what this is what we're looking at. So rather than looking at the income approach, now we're looking at the economy from the expenditure approach. Again, let's work a simple example. Let's assume in a simplified economy, we only had four sectors, household, which represent the consumers, businesses, government and the rest of the world. So suppose from a consumption perspective, all the household and this economy spent five million dollars on goods and services. And this includes things like food, clothing, healthcare, entertainment. They went crazy and they spent five million dollars. Businesses, which represent the investment part of this equation, invested two million dollars in capital goods. They bought machinery, equipment, computers. They had to buy inventory to run their businesses. So on and so forth, total of two million. We have government spending. Suppose the government spend three million dollars. How did they spend it on public services? Infrastructure, roads, airports and other expenditure. Like they might have employees, they might have consultants, so on and so forth. For net export, which is export minus import. And suppose the economy exports goods worth of a million and import goods worth of two million. What does that mean? It means overall, we have a negative net export because we are buying more than what we're selling from the world. So how do we compute a GDP? Well, here we go. We're going to take the five million consumed by the consumer, the two million by the businesses, three million by the government, minus the one million and we come up to an answer of nine. Now just real quick, I just want to show you what does that mean? What does this equation tells us? What this equation tells us, simply put, if we look at only the positive, let's keep the export minus import out. We see that of the 10 million, the consumer represent 50% of GDP. It means the consumer represent a majority of the GDP. And that's why the expenditure is a good approach, because you can see how much the consumer represent overall of the economy versus the other sectors. For example, in the US, the consumer represent around 67%, which is approximately two-thirds of the economy, two-thirds of GDP is consumers. And that's why the US consumer is a strong consumer. That's why everyone wants to sell in the US because we have a strong consumer. At the same time, what does that tell us? It tells us if the consumer loses confidence, which we're going to talk about leading indicators, lagging indicators, it measure the consumer confidence. When the consumer represent a large portion of GDP, you have to measure the consumer confidence very closely, because assuming this is a real economy, what I care about is how is the consumer doing? If the consumer stops spending, I'm in trouble. If the consumer, which is the people, the household, are losing their job, we're going to be in trouble. Why? Because if they're losing their job, they don't have money to spend, they don't have money to spend, the economy will contract. Like what happened during COVID? Millions and millions of people lost their job in the US. And as a result, the economy should have half contracted. So what happened instead? The government says, guess what? We're just going to give you money. Why? Because we want the sea of GDP to keep on running, keep on spending. There are pros and cons to this. I'm just making the point why this computation of GDP is the most common and it's the most relevant, in my opinion. Now, bear in mind all three methods are acceptable, okay? But this nine million number represent the total spending on final goods and services in the economy over a specific period. Now, as a measurement tool, we can compare year one to year two to year three and see how well we are doing as an economy. The last thing I'm going to focus, I'm going to cover is the difference between GDP and something called GNP. N stands for national, national GDP versus G national. Now, GDP, as we mentioned earlier, it includes everything produced by all individuals and companies within a particular country. And remember I showed you the US map to make the point that GDP is a geography approach. You're looking at a country. GNP, gross national product, it's the total value and services produced by the company's, a country's resident no matter where they live in the world. What does that mean? It's a nationality approach. For example, if you have a US citizen living in Europe and producing in Europe, now GNP will count that US citizen, okay? If you have US citizen in China and the Middle East working, well, if we're looking at GNP, we will count their income as part of the GNP. If we're computing GNP, we don't unless you are in the US. So the GDP, however, lives in the US residency. GNP is citizenship. So GDP is measuring the country's overall health and living standard, overall for the whole country. GNP is measuring the economic health and living standards of the citizens. It means only US citizens were looking at the nationals, the citizens. And this is the difference between the two. Just make sure you know the two, but most likely you have to know GDP because we're looking at an economy. We're looking at the country. We don't care about the nationals. What if the nationals all moved to France? Well, guess what? Is then the GDP of the US will change because if they're producing in France, what we care about is people spending in the US because that's what's gonna keep the economy on moving. I don't care about GNP, I care. We care about GDP. But if you wanna know the citizens' economic health, you would look at GNP. What should you do now? If you're studying for your CPA exam, I suggest you visit Farhat Lectures. I have plenty of MCQs that's gonna help you understand the economic portion of it. Economic portion, go to Farhat Lectures, solve MCQs, look at additional resources that's gonna help you. Good luck, study hard, and of course, stay safe.