Investment and consumption | GDP: Measuring national income | Macroeconomics | Khan Academy
- Articles, Blog

Investment and consumption | GDP: Measuring national income | Macroeconomics | Khan Academy

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.

About James Carlton

Read All Posts By James Carlton

23 thoughts on “Investment and consumption | GDP: Measuring national income | Macroeconomics | Khan Academy

  1. I have always been interested in economics, but being an computer science guy I haven't got the time to go to classes – except now I do! Thanks a lot, Salman! 🙂

  2. Also you dont include the idea that houses arent owned they require upkeep and an ever increasing tax revenue per annum. That 25 percent of homeowners in the US owe more than the property is worth. Also, that as the cost of energy increases, suburbia and land ownership becomes less of a "asset".

  3. I'm confused what is the third category? Recycling? I would think an economist would have an emphasis on efficient use of resources than just how much businesses create new.

  4. What if you consume protein shakes to work out and go to your job as a bodyguard? Would the protein shakes be considered consumption or investment?

  5. Professor Khan, Can you categorize your videos and place numbers or chapters on them? For instance this would be Economics: Chapter 2, number 1. I think it might help as you post videos. I still can't believe you haven't won the Times "Person of the Year" or the Nobel Peace Prize. My daughter, Taylor is still wondering whether you can do the MCAT's. She's taking MCAT classes at MIT. She's very impressed with the campus and loves going there. Thank you very for all you've done for my kids.

  6. Hi, just one question: so renting a house would also fall in consumption, is that right?

    Or what about buying a house from someone else or second-hand cars/things? are they included or are they not part of the formal economy?


  7. Hello Sir,
    As you mentioned that car in the economic consumption so my question to you is what if an individual buys a second hand car for a temporary basis. How to bifurcate in that case?

  8. If you buy a bond it should not be included in GDP and rent paid is part of consumption. I had this in lecture for macroeconomics.

  9. Some of you are taking some of the thoughts way too deep. What is presented here are basic macroeconomic concepts. Not business concepts. The reality of some of the concepts may be different, but they are what is taught in a basic or AP macro class.
    But….olufsenn….good question. And tomorrow would it be exports?

  10. Hi, I have a question, let's say, For example: let’s say a country with a total GDP 1.96 Trillions.
    A company (X) contributes 11.1 Billions into the economy GPD.
    Which 0.6%.

    How the percentage 0.6% came from. What is the method or equation being used to come up with this percentage?

Leave a Reply

Your email address will not be published. Required fields are marked *