Gross Domestic Product (GDP)

In macroeconomics, the most common way economists  and policymakers measure the health of an overall economy is by examining gross domestic product,  or GDP. Gross means total, domestic means within a country’s borders, and product means the value  of all goods and services produced. However, that’s a bit of an oversimplification,  so let’s look at the complete definition.

Gross domestic product is the value of all  final goods and services produced within a country’s borders in a given year. Note the  emphasis on “final” and “in a given year. ” Final goods are also called “finished goods.

” A  final good is one that will not be sold again as part of some other good. If a baker buys flour,  sugar, and butter, we don’t count those as final goods, because the baker will use those goods to  make a cake. In other words, they are goods that aren’t finished yet, they are intermediate goods. 

Now, the cake the baker made using that flour, sugar, and butter, is a final good since the cake  is the final product, and its final destination is the consumer. In other words, a customer will buy  it and consume it. There are also goods that are used to make other goods but are still considered  final goods.

These are called “capital goods. ” For example, if a farmer buys a combine to harvest  his crops, the combine is considered a final good. Even though the combine is used to produce other  goods, it won’t be sold again as part of another good.

There are also capital goods used to provide  services counted as final goods. For example, if a landscaper buys a chainsaw in order to take down  trees, the chainsaw is considered a final good. GDP also only counts production in a given  year.

If an old car is sold this year, economists don’t count it as part of GDP since  the car wasn’t produced this year. They only count new cars sold this year as part of GDP.  Also, production is only counted if the good or service is produced within a country’s borders. 

For example, if you are in the United States and buy a shirt imported from Vietnam, that adds to  Vietnam’s GDP, not the United States GDP. But a movie made in the United States that is shown in  theaters in Vietnam adds to the United States GDP. It’s helpful to think of the entire economy  of a country as one big hypermarket store, meaning they sell pretty much everything you could  possibly ever want to buy.

Not just products like food and clothing, but also services like pet  grooming and tax preparation. Every time a consumer buys a final good or service, we record  the cost, just like at a cash register. All the cost combined over a given year is the GDP.

Government economists often divide final goods and services into four categories. Consumer  goods and services, business goods and services, government goods and services, and net exports.  Net exports are found by simply adding up exports and subtracting imports.

Government economists can  also calculate GDP using another method. Instead of adding up all the stuff that consumers,  businesses, and the government buys, it can add up all the incomes in the economy. There is  also nominal GDP and real GDP.

Nominal GDP is measured in current prices. Real GDP is measured  in constant, or unchanging prices. In other words, real GDP is nominal GDP but adjusted for  inflation.

Real GDP is a more accurate way to measure economic growth, since inflation can  distort the actual value of goods and services. However, GDP is not a perfect way to assess the  health of a country’s economy. First of all, GDP doesn’t take into account many things that could  be considered part of an economy.

For example, it doesn’t measure non-market activities, or goods  and services that people make or do themselves, like mowing their own lawn or washing their own  car. It doesn’t measure the underground economy, like in the black market, or market for illegal  goods, as well as transactions that are legal but simply not reported. GDP also doesn’t measure  unintended negative externalities.

For example, a power plant that creates air pollution by  emitting dust and smoke into the air is not subtracted from the GDP. GDP makes no adjustment  for leisure time. For example, if workers get more time off in one country yet produce the  same amount, they are not rewarded for it.

GDP counts goods and services even when  those goods and services are created after disasters. For example, if a tornado wipes out  a building, GDP automatically increases when a new building takes its place. And finally, GDP  doesn’t account for how goods and services are distributed.

It doesn’t affect the GDP if lots  is produced and most of it only goes to a small minority of the wealthiest individuals. One way economists attempt to calculate a slightly more accurate measure of a country’s  economy is by figuring out its GDP per capita. Like the name suggests, to get GDP per capita  you just take a country’s GDP and divide by its population.

To quickly illustrate this  difference, let’s look at Germany and China. In 2020, China’s GDP was 17. 7 trillion USD and  Germany's GDP was 3.

8 trillion USD. However, Germany’s GDP per capita was 45,724 dollars and  China’s GDP per capita was just 10,511 dollars. Some economists have called for alternatives to  GDP, in order to more accurately assess the health of a country’s economy with a general emphasis  on quality of life.

Some of these alternatives include the Human Development Index, Inclusive  Wealth Index, and Genuine Progress Indicator. Regardless, gross domestic product continues  to be the go-to metric government policymakers rely on when planning for their country’s economic  future, because institutions are better equipped to measure its components, and the clarity of  its definition reduces the likelihood of infusing bias. In this way, GDP remains the primary way  to quickly measure the health of an economy.