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

Summary

This video script delves into the concepts of investment and consumption, contrasting their everyday meanings with their economic definitions. It explains that while everyday investment is about activities for future gain, like building a house or education, economics narrows it to capital equipment, inventory, and new structures. Consumption in daily life refers to short-term use items like eating a candy bar, but economically, it's spending on final goods by households, excluding new homes. The script aims to clarify these terms for understanding GDP composition.

Takeaways

• 🏡 Investment in everyday terms is about actions taken to gain future benefits, such as building a house or buying a bond.
• 🎓 In the everyday sense, education is considered an investment because it's expected to yield long-term returns like better employment and higher wages.
• 🍭 Consumption is short-term spending on goods or services that are used up immediately, like eating a candy bar or watching a movie.
• 💼 Economically, investment is more precisely defined as spending on capital equipment, inventory, structures, and new homes by firms and households.
• 🏢 Capital equipment in economics includes machinery, robots, assembly lines, and other tools used by businesses to produce goods or services.
• 📈 Economic investment also encompasses the construction of new homes, which is considered an investment when done by households.
• 🏠 Buying an existing house is not counted as investment or consumption in economic terms because it's merely an asset transfer, not the creation of new capital.
• 🛍️ From an economic perspective, consumption is any spending by households on final goods, excluding new homes, which are classified as investment.
• 💼 Education spending is considered consumption in economic accounting, even though it might be seen as an investment in everyday terms due to its long-term benefits.
• 🚗 Buying a car is categorized as consumption in economic terms, despite potentially providing future benefits like enabling work commute, because it's a purchase of a final good.

Q & A

What is the main purpose of the video?

The main purpose of the video is to compare the concepts of investment and consumption in both everyday and economic contexts, particularly in relation to how they contribute to GDP.

How does the speaker define investment in everyday terms?

In everyday terms, investment is defined as something done to gain future benefits, such as building a house, buying a financial instrument, or pursuing education.

What is an example of investment given in the video?

An example of investment given in the video is building a house, which provides future gains like saved rent and continued use over time.

What is the economic definition of investment according to the video?

Economically, investment is defined as spending on capital equipment, inventory, structures, and new homes by firms and households.

Why does the video distinguish between everyday and economic definitions of investment and consumption?

The video distinguishes between everyday and economic definitions to clarify how these terms are specifically used in accounting for GDP, which requires more precise and trackable definitions.

How is consumption defined in everyday terms in the video?

In everyday terms, consumption is defined as buying or doing something that will be used up in the short term, like eating a candy bar or watching a movie.

What is the economic perspective on consumption as presented in the video?

Economically, consumption is considered to be any spending on newly produced final goods by households, except for new homes.

Why is the purchase of a new home considered an investment rather than consumption in economic terms?

The purchase of a new home is considered an investment in economic terms because it involves the production of a new capital asset, which is not merely a transfer of an existing asset.

How does the video explain the difference between investment and consumption in the context of GDP?

The video explains that in the context of GDP, investment includes the production of new capital equipment, inventory, structures, and new homes by firms and households, while consumption includes spending by households on newly produced final goods, excluding new homes.

What is the significance of the distinction between investment and consumption for understanding GDP?

The distinction between investment and consumption is significant for understanding GDP because it helps to categorize and measure the different types of economic activities that contribute to the total output of a nation.

Why does the video mention that the purchase of a factory does not add to GDP?

The video mentions that the purchase of a factory does not add to GDP because it is merely the transfer of an existing asset and does not involve the production of new capital equipment or structures.

Outlines

00:00

🏡 Investment vs. Consumption: Everyday vs. Economics

The paragraph introduces the comparison between investment and consumption in both everyday and economic contexts. It explains that investment generally refers to actions taken for future gain, such as building a house or buying a financial instrument. Consumption, on the other hand, is short-term spending on goods or services that are used up immediately, like eating a candy bar or watching a movie. The paragraph emphasizes the importance of understanding these terms in the context of GDP, where investment includes capital equipment, inventory, and new structures, while consumption is more short-term and does not include asset transfers.

05:01

💼 Economic Definitions and GDP Accounting

This paragraph delves into the economic definitions of investment and consumption, which are more precise and easier to account for in terms of GDP. Economic investment is defined as spending on capital equipment, inventory, and new structures or homes by firms and households. Consumption, from an economic standpoint, is any spending by households on final goods, excluding new homes. The paragraph clarifies that the purchase of existing assets, like buying a factory or a car, is not considered investment or consumption for GDP purposes as no new production is involved. It also discusses the accounting of education and car purchases, which, despite having long-term benefits, are classified as consumption in economic terms due to their straightforward accounting nature.

Keywords

💡Investment

In the video, 'investment' is defined as an action taken to secure future gain, which can be either in the form of tangible assets like building a house or intangible assets like education. The speaker uses the example of building a house to illustrate how it is an investment because it provides shelter and potentially saved rent in the future. In an economic context, investment is more precisely defined as spending on capital equipment, inventory, structures, and new homes by firms and households.

💡Consumption

Consumption, as discussed in the video, refers to the act of using up goods or services in the short term for immediate benefit. The everyday example given is eating a candy bar, which is a one-time use and provides immediate satisfaction but no long-term gain. Economically, consumption is defined as spending by households on final goods, excluding new homes, which are considered investment. The video emphasizes that consumption is not necessarily inferior to investment; it's a different form of spending aimed at immediate utility.

💡GDP (Gross Domestic Product)

GDP is a key economic indicator that measures the total value of goods and services produced within a country's borders over a specific period. The video script discusses how understanding the concepts of investment and consumption is crucial for accounting for GDP. It's mentioned that the production of new capital equipment, inventory, structures, and homes contributes to GDP, highlighting the importance of these activities in economic measurement.

💡Capital Equipment

Capital equipment, as mentioned in the script, includes the machinery, tools, and installations used by businesses to produce goods or provide services. Examples given are robots, assembly lines, and wheelbarrows used in a factory. These are considered investments because they are used to generate future production and, consequently, future economic gains.

💡Inventory

Inventory in the economic sense refers to the stock of goods that a company holds for future sale. The video explains that inventory is considered an investment because it represents raw materials or goods that will be used to produce something of value in the future. It's part of the production process that contributes to GDP.

💡Structures

Structures, as discussed in the video, include buildings and other constructions that are used for production or service provision. They are considered investments because they are long-lasting assets that provide a platform for economic activities and contribute to the country's productive capacity.

💡New Homes

The construction of new homes is highlighted in the video as a form of investment made by households. It is distinct from buying an existing home, which is a transfer of an asset and does not contribute to GDP. New home construction is an investment because it creates new assets that provide future shelter and potential rental income.

💡Education

Education is presented in the video as an everyday form of investment where individuals invest time and money to gain future benefits, such as better employment opportunities and higher wages. However, from an economic accounting perspective, spending on education is classified as consumption because it is a service provided to households.

💡Financial Instruments

Financial instruments, such as bonds mentioned in the video, are considered investments because they represent a claim on future earnings. When an individual buys a bond, they are essentially lending money with the expectation of receiving interest or profit in the future, which is a form of investment in the everyday sense.

💡Economic Definitions

The video script distinguishes between everyday and economic definitions of terms like investment and consumption. Economic definitions are more precise and are tailored to facilitate the accounting and measurement of economic activities, such as GDP. These definitions are crucial for understanding how economic data is collected and interpreted.

💡Accounting for GDP

Accounting for GDP involves tracking and categorizing various economic activities, such as investment and consumption, to measure a country's economic output. The video explains that economic definitions of investment and consumption are designed to make this accounting process more systematic and accurate, focusing on new production and final goods spending.

Highlights

The video aims to compare investment and consumption in both everyday and economic contexts.

Investment is generally viewed as something done for future gain in both everyday and economic senses.

Building a house is an example of an investment as it provides future housing without the need for rent.

Financial instruments like bonds are considered everyday investments as they pay off with interest or profits.

Education is often seen as an investment because it can lead to better employment and higher wages.

Consumption, in everyday terms, is buying or doing something for short-term use or benefit.

Eating a candy bar or watching a movie are examples of consumption as they provide immediate satisfaction.

Economic definitions of investment are more precise and focus on spending on capital equipment and structures.

Capital equipment includes machinery, robots, and inventory that are used to produce future goods.

The construction of new homes by households is considered an investment in economic terms.

Buying an existing house is not considered investment or consumption in economic accounting as no new production occurred.

Economic consumption is defined as spending on newly produced final goods by households, excluding new homes.

Educational tuition is considered consumption in economic accounting despite being an investment in everyday terms.

Buying a car for work is considered consumption in economic terms, even if it provides future benefits.

Economic definitions are designed to be easier for governments to account for in GDP calculations.

Spending by firms is categorized as investment because it is aimed at producing goods or services.

Household purchases of new homes are considered investment for accounting purposes.

All other household spending is categorized as consumption in economic accounting.

Transcripts

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.