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Investment and consumption

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What an economist means when they say "investment" is different than what most people mean when they use it in day-to-day conversation. In this video, take a deeper dive into the investment category of real GDP. Created by Sal Khan.

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  • leaf green style avatar for user ram_abhiram
    At Sal says that, only new homes contribute to GDP; but,say a house is sold for $100 in the year in which it was built and is resold two years later for $300, does the $200 appreciation contribute to GDP?
    (22 votes)
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    • blobby green style avatar for user Saad Ghazipura
      Remember back in the first video when market value of the Avocado changes from $1 to $0.50 so does the GDP effect it has however like someone else stated it is within a given period. The first time the house is sold its value to the GDP is $100. If a new house was built with the exact same specifications 2 years later it would now be worth $300 to the GDP however, even though the first house's value has increased it does not affect the GDP because the purpose of the GDP is to measure new growth within a given period and the first house is NOT new growth.
      (59 votes)
  • leaf blue style avatar for user Jacob Cutts
    In the video, the example of a factory is used. It seems logical that capital equipment, inventory, etc count as an investment, but one thing that isn't clear is something such as electricity. It seems to me that the factory's electricity usage would logically be considered consumption, but the video also says that consumption is done by households. Was this mistakenly specified, or is electricity not "consumed"?
    (18 votes)
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    • starky ultimate style avatar for user Geoff Ball
      Great question, Jacob. Although the firm is "consuming" electricity in the typical sense of the word, it would not count toward consumption. Instead, think of electricity as an input toward an end product. In that sense, the firm is investing in electricity so that it can more efficiently produce a good or service.
      (44 votes)
  • spunky sam blue style avatar for user Virak Khiev
    I wonder how the the government keeps track on my one-dollar expense of an apple which I buy almost everyday, for example, and I can't see any government official come along me to record this one-dollar expense? So, please tell me how this one dollar contribute to the GDP of my country.
    (12 votes)
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    • blobby green style avatar for user Aayush Agarwal
      You are buying only an apple but the person you are buying from sells numerous apples and to keep record how many apple he sold he keeps a stock statement , in that statement the value of the stock sold and stock remaining is there and that final value comes under balance sheet and profit & loss account , finally giving the total earnings with regard expenses comes and when that firm pays taxes to the govt , they submit this balance sheet giving the govt an idea that what worth of final goods and services are being circulated in the economy .
      (5 votes)
  • leaf red style avatar for user 12campi
    How would you classify in economic terms giving an educational resource like a book to someone if the book has not been produced recently? I feel like it could be classified as another investment separate to the original purchase because the new person to receive the book will be more educated At the same time, the book has been around a while, and it is a recyclable resource...
    (5 votes)
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    • leaf grey style avatar for user Shlomo Fingerer
      You would be increasing the efficency of the existing capital structure. If you could charge for it, for example if you sold membership in you're library, then it would be considered. If you did it as a non-profit, it would not be counted (Just like we only count babysitting that you pay for, & not when you babysit your own kids!). There is a growing sense in the economics comunity however, that we need a more comprehensive measure of well being than GDP, which is primarily dollars and cents... Hopefully one of you guys will right a thesis on it, and win a noble in econ...
      (5 votes)
  • leaf blue style avatar for user Xosian
    So only a HOUSE wouldn't be "consumption" in the economic sense? Whereas a car and education WOULD? Can someone explain this? Thank you..
    (5 votes)
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    • blobby green style avatar for user Isaac Legred
      The fact that only a New* house is investment is essential to measuring economic growth. The point is that there needs to be some point to measure from; you could very well make a new car an investment but it isn't so to answer the question a car and an education are Recognized as consumption, meaning that consumers will buy these things without any direct intention of creating a profit in the future i.e. I can't sell my college degree or lease it out whereas I very easily can lease out my house. It's more a technicality, albeit a logical one, that states that the only a new house can be an investment for a household. It stems from the fact that businesses invest and households consume, and once a household invests it becomes something of a business Unless* it is a New* house.
      (6 votes)
  • leaf orange style avatar for user Dmitry Gracy
    Inventories. Well, in the previous video (Parsing Gross Domestic Product) Sal was parsing GDP with jeans example and coton which is raw material for the jeans was not counted in GDP but the final price of the jeans contributed to GDP. Here raw materials (inventories) are counted in Investment thus in GDP. It is not really clear for me what to do with raw materials. To count it as Investment and then subtract its value from the market price of final goods or not to count it in Investment but let the final price contribute fully to GDP or else? How does it work with raw materials in real? Thanks
    (7 votes)
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    • leaf orange style avatar for user Dmitry Gracy
      Thank you Saxet. Well, you say the producers subtract the inventories ( COST) from the final price to get the gross income - OK. But, we are talking about the expenditure point of view of calculating GDP and not the income point of view. According to the definition given in "Parsing Gross Domestic Product video" we have to count only FINAL GOODS & SERVICES and INVENTORIES are not final goods. Equipements for a factory are final goods but raw matearials are not :)
      So, if we count raw matireals and final price of the final good made of that raw matearial we would get double counting I think ...wouldn't we? I base my reasoning on the 2nd video with the jean's example.
      (2 votes)
  • leaf blue style avatar for user arturorufino0033
    Ok, so I have 3 questions.
    (1) What about a financial investment like a New Bond, is that consumption in the economical view?
    (2) What do we call the GDP that actually gets sold, and (3) what do we call the items sold number that gets deducted from the GDP?
    (3 votes)
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    • spunky sam blue style avatar for user jacobsmithguitar
      (I) All financial investment that does not create anything tangibly valuable–e.g. investment that basically just shifts money around–does not count in GDP because nothing is being produced. GDP is only supposed to count the market value of all final goods produced in an economy. Thus, if I pay you to use your money, I am not producing anything, so I am not contributing to GDP. You have to spend the money I give you on a final good or service before it will count as consumption or investment.

      (II) "What do we call the GDP that actually gets sold"?
      Goods do not count in GDP unless they do get sold. If a company has a surplus, that company will lower prices until it sells the surplus. The lowered price will be the market value of those goods, and that price will be added to GDP. If goods are not sold, then there is no genuine way to determine their market value. Plus, they don't contribute to national income or revenue, which are both supposed to be basically equal to GDP.

      (III) "What do we call the items sold number that gets deducted from the GDP?"
      I don't know what you mean, and if I did I wouldn't know the answer to your question. Sorry.
      (3 votes)
  • piceratops seedling style avatar for user olyleperez
    Just to make things clear, EVERYTHING that a household spends on is, in economic terms consumption, however the absolute only exception to this rule is when a household buys a new house. Why should buying a new house be investment, and not consumption. I just don't get it...
    (4 votes)
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  • female robot grace style avatar for user Natalie
    Would renovations on a house which increase that house's value be counted under GDP, if the house was then sold?
    (3 votes)
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  • blobby green style avatar for user Kevin Joseph
    Wouldn't inventory be a short term purchase because you are selling the inventory for gain in the period? I thought capital refers to purchases for gains over multiple periods.
    (3 votes)
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    • orange juice squid orange style avatar for user Owen Sechrist
      You're basically correct in your thinking, however, consider what happens if you don't count inventory that exists at the end of a period....

      All the goods that have been produced further down the supply chain would not be counted because they have not been made into a final good/service yet. Therefore we need to count existing inventory at the end of a period to get a true idea of what has been produced in that period.
      (3 votes)

Video transcript

What I want to do in this video is compare investment to consumption. And we're going to think about it in two contexts. One I would call the everyday conventional context. And then the other one would be how we would think about it in an economics context. Because these words mean something very particular to an economist. And that's important that it means something particular, because we're going to start using these words, or this terminology, or these classifications, to understand where GDP is coming from. So in everyday-- let me draw a line over here. This is going to be everyday or, conversational, versions of this term. And down here, we'll put the economics, the economic versions of this term, especially when we think of it in the context of accounting for GDP. And they're not necessarily all that different. But they are different in important ways. So in investment, really in both cases, you can generally view it as something that you do to get some future gain. So for example, if I today build a house-- so I build a house. So that is the house. I built it today. And this will be the timeline. The house will keep lasting. And it's an investment, because it's going to be giving me future gain. A year from now, I'll still be able to live in that house. So I will have the saved rent. That's a future gain, a future gain two years from now. It'll keep giving some type of gain. You could have a financial instrument, maybe some type of debt instrument. You're lending money to someone else. So maybe you buy a bond, which is essentially you lending money to someone else. That is an investment in the everyday sense of it. Because when have that asset, when you've bought that asset, it's going to pay off something in the future. It's going to pay off some interest or some profits. And in the everyday sense, I would consider something like-- hopefully it would be-- going to college would be an investment. So education, I'll say education, because you invest that time and energy and education, it's going to keep paying off. Hopefully by doing that, you're going to get better employment and higher wages the rest of your life. It will keep paying off. So this is the everyday notion of investment. The everyday notion of consumption, the way I think about it, is you are buying something or you're doing something that you're just going to use up in the short-term. And just by using it up, whatever that object is, if you just use it up-- and it's just going to hopefully benefit you in some way, but it's more of a short-term thing-- I would consider that consumption in the everyday sense. So if you go buy a candy bar and eat it, you have consumed the candy bar. You have not made an investment. If you go to a movie, that is consumption. And I'm not making any value judgment that one is better than the other. Investment, at the end of the day, you're investing so that you can get future benefit that could lead to consumption. Because at the end of the day, consumption is one of the things that might make your life a little bit better off. So I'm not saying that one is better than the other. But watching a movie, that would also be consumption. Spending time buying a book, well, you could debate whether that's education or not. But let's say you buy a book that is not educational, that is consumption. But it is making you happier. Hopefully, it's making your life better in some way. Now, the economic definitions are related to these everyday definitions, but they're a little bit more precise. And they make the definitions in a way that they're easier to account for if you are a nation. They're easier to keep track of. So the way an economist would define it, they would define economic investment as spending on capital equipment. Capital equipment are things like, if you are a factory, you will buy the equipment to run your factory. You buy the robots. And you buy the assembly line. And you buy the wheelbarrows or whatever else, the things that have to cart things around. That is capital equipment. It would be things like inventory. So for example, the inventory-- and this is still not so different. Both of these things are being used to produce things in the future, to produce future benefit. You're buying that inventory, sometimes raw material, you're going to add value to it. And then they're going to be used to produce something in the future. It includes things like even the structures, the buildings. And so for all of this, in the economic sense, and this is why it's easier to account for, this, for the most part, is being done by the firms. And it also includes the one thing that households do, which is construction of new homes. This is from the households. Actually, the buying of a house does not show up in consumption or investment, because nothing new was produced. Something just exchanged hands. So whenever we talk about any of these things, especially when we're talking about it in precise economic terms, it's the production of new capital equipment, new inventory, new structures, new homes. If I just buy a factory from someone else, that does not add to GDP. It would not be considered investment or consumption, because I'm just transferring an asset from one person to another. It would only be added to GDP when it is first created. And on the consumption side, from an economic point of view-- let me draw a little bit of a line right over here-- consumption is considered to be any spending on final goods by households except for new homes. And let me make this even clearer. Because remember, if we're just transferring goods, that shouldn't count. So let me put it on newly produced final goods. Now, what's unintuitive a little bit over here is, according to the way we account for GDP, the tuition that you spend on a college education, that is new spending on final goods. And here are the final goods or services. The service you're getting is your education. That would be consumption. So education would fall here in the economic sense. While in the every day sense, I would consider education right over here. Maybe you are buying a car. And you're not buying a car for leisure purposes. You're buying a car because you need your car to go to work. There's an argument that that would be an investment in the everyday sense. By having that car, you have something that can take you to work every day. So you're getting future benefit. So there's an argument that maybe that's an investment in the everyday sense. But in the accounting sense, that car would sit right here. You bought a new car. But that is considered consumption. You did not buy a new house. And the whole reason, at least as far as I understand, why it's set up this way is this is this easier to account for. You look at all of the spending by firms, that's easy to account for. You essentially call that investment. Because at the end of the day, all the spending that firms are making is they're doing it to produce some good or service. So we call this investment any spending that the firms do. And on top of that, when households purchase new homes, we also call that investment. And that's just easier for the accounting offices of governments to keep track of. And everything else that households do, we consider consumption. And we'll see in the next few videos, there are a few other categories in terms of things that the government do. And then we'll have to think about imports and exports.