Introduction to Finance

capital formation
and results in economic growth.
capital formation 
process 
of constructing real property, 
manufacturing producers’ durable 
equipment, and increasing business 
inventories

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7.1 Gross Domestic Product and Capital Formation
167
GDP Components
Recall that 
gross domestic product (GDP)
is a nation’s output of goods and services achieved 
over a specifi ed period, such as one year. Increases in GDP over time measure the extent of 
economic growth, one of the country’s national economic policy objectives. In Chapter 2, we 
focused on the relationship between GDP and monetary policy in terms of the money supply 
and velocity. 
GDP is composed of consumption and investment components, as well as the net export 
of goods and services. More specifi cally, GDP consists of four components:
1.
Personal consumption expenditures
2.
Government expenditures, including gross investment
3.
Gross private domestic investment 
4.
Net exports of goods and services
Personal consumption expenditures (PCE)
indicate expenditures by individuals for 
durable goods, nondurable goods, and services. We all like to eat, buy clothes, have roofs 
over our heads, enjoy the comforts of heating and cooling, benefi t from interior lighting, own 
automobiles and televisions, receive education, travel, and get haircuts and other services. The 
fact is we consume throughout our lives. Depending on where we are in our life cycles, we 
typically meet our consumption desires by spending our parents’ earnings and savings during 
our formative years from birth through college graduation, generating our own earnings dur-
ing our working lives, and spending our own savings during our retirement years.