A Little Wear and Tear

• Suppose for example, that the economy's gross domestic product is a grand total of $10 trillion, with $2 trillion of this total consisting of investment expenditures for capital goods. A $2 trillion total for capital goods production suggests that the economy is likely to achieve significant economic growth in the year to come.


• However, economic growth is likely to be less substantial if a portion of this capital investment is merely used to replace capital depreciated over of the year in the course of production. If, for example, $1 trillion worth of capital wears out, breaks down, or becomes technologically obsolete during the year, then the economy ONLY has $1 trillion worth of ADDITIONAL capital that can be used to promote economic growth. In fact, if capital depreciation is a full $2 trillion, then there is NO new capital available for economic growth. There is NO capital-inducing economic growth.


• It could be even worse. Should capital depreciation exceed $2 trillion, then not only is the economy NOT expanding, it is actually shrinking. The production of new capital is not enough to replace the depreciated capital, let alone add extra growth-promoting capital. The capital stock is actually smaller at the end of the year than at the beginning.

While capital depreciation rarely exceeds capital investment, in a given year, a sizeable portion of capital goods are used to replace depreciated capital. During the 1960s and 1970s, capital depreciation was in the range 40-60 percent of capital investment. Into the 1990s and beyond, this fraction was in the 80-90 percent range.

Doing a Little Adjustment

Net Domestic Product

NDP

=

GDP - CCA

The CCA in this equation stands for capital consumption adjustment, the official term for capital depreciation.

A simple rearrangement of terms provides an alternative way to express the relation between GDP and NDP:

GDP

=

NDP + CCA

In essence, both equations indicated that gross domestic product can be separated into two components--net domestic product and capital depreciation.

This separation is graphically illustrated in this diagram. The two-toned column on the left represents gross domestic product. This column is two-toned because it can be separated into capital consumption adjustment, which is the top red portion, and net domestic production, which is the lower blue portion. The center column then indicates that portion of gross domestic product going to the capital consumption adjustment. The right column then indicates the portion of gross domestic product that remains for net domestic product.

A Little Bit About Net National Product