What GDP measures
Gross domestic product (GDP) is the market value of all final goods and services produced within a country in a year. Three parts of that definition matter:
- Final goods only. Flour sold to a bakery is an intermediate good; counting it and the bread would double count.
- Produced this year. Selling a used car moves ownership but creates no new output, so only the dealer's fee counts.
- Within the country. A factory in Ohio owned by a foreign firm counts in US GDP.
The expenditure approach
GDP = C + I + G + (X − M)
- C: household consumption. I: investment (business equipment, new housing, inventories; not buying stocks). G: government purchases of goods and services (not transfer payments such as pensions). X − M: exports minus imports, or net exports.
Worked example
In a small economy, consumption is 600, investment 150, government purchases 200, exports 80 and imports 100 (all in billions).
GDP = 600 + 150 + 200 + (80 − 100) = 930. Net exports are −20, a trade deficit.
Nominal and real GDP
Nominal GDP uses current prices, so it can rise just because prices rose. Real GDP uses constant prices from a base year. The GDP deflator = (nominal GDP ÷ real GDP) × 100.
If nominal GDP is 1,100 and the deflator is 125, real GDP = 1,100 ÷ 1.25 = 880. If real GDP next year is 924, real growth = (924 − 880) ÷ 880 = 5%.
Growth and living standards
Real GDP per person is the usual measure of average living standards. Growth comes from more capital, more or better-educated labour, and better technology (productivity). Small differences in growth compound. The rule of 70 says a quantity growing at g percent a year doubles in about 70 ÷ g years: at 3.5% growth, real GDP per person doubles in about 20 years.
Limits of GDP
GDP leaves out unpaid household work, the underground economy and leisure, and it does not subtract pollution or resource depletion. It also says nothing about how income is spread across people. It is a useful but incomplete measure of well-being.
The business cycle
Output tends to move through expansions and recessions, with a peak and a trough. A common rule of thumb defines a recession as two consecutive quarters of falling real GDP, though official dating uses broader evidence.