Measuring the economy: GDP
Gross domestic product is the single most watched number in economics. It measures the total value of what an economy produces.
What macroeconomics studies
Macroeconomics studies the economy as a whole: total output, overall prices, unemployment, interest rates, and international flows. Its central questions are why economies grow, why they sometimes shrink, why prices rise, and what governments and central banks can do about it.
Defining GDP
Gross domestic product (GDP) is the market value of all final goods and services produced within a country in a given period, usually a quarter or a year. 'Final' means goods sold to their end users, not intermediate goods used to make other goods, to avoid counting the same production twice.
Avoiding double counting
If a farmer sells wheat to a baker for 1 dollar and the baker sells bread for 3 dollars, GDP rises by 3 dollars, not 4. Equivalently, GDP is the sum of value added at each stage: the farmer adds 1 dollar, the baker adds 2. The value-added approach gives the same answer.
What GDP leaves out
GDP excludes second-hand sales (already counted when new), purely financial transactions like buying shares, and transfer payments such as pensions. It also leaves out most unpaid work, like childcare and housework done at home, and the informal or illegal economy, which can be large in some countries.
The expenditure approach
GDP can be measured by adding spending on final goods: GDP = C + I + G + NX. C is household consumption; I is investment (business equipment, buildings, new housing, and changes in inventories); G is government purchases; NX is net exports (exports minus imports). In the United States, consumption is roughly two-thirds of GDP.
The income approach
Every dollar spent on output becomes someone's income, so GDP can also be measured by adding wages, profits, rent, and interest, plus some adjustments such as indirect taxes and depreciation. In principle the expenditure and income approaches give the same total; statistical differences are small.
GDP and GNP
Gross national product (GNP), or gross national income (GNI), measures output by a country's residents wherever they are, while GDP measures output within the country's borders. For countries with lots of foreign-owned firms, such as Ireland, GDP can be much larger than GNI.
Worked example
An economy has consumption of 700, investment of 200, government purchases of 250, exports of 150, and imports of 180 (billion dollars). GDP = 700 + 200 + 250 + (150 - 180) = 1,120 billion dollars. Imports are subtracted because they are already included in C, I, and G but were produced abroad.
Key takeaways
Macroeconomics studies the whole economy. GDP is the market value of final goods and services produced within a country in a period. Counting only final goods or value added avoids double counting. GDP excludes second-hand sales, transfers, and unpaid work. GDP = C + I + G + NX; the income approach gives the same total. GNI counts residents' output wherever produced.
Flashcard
Study of the whole economy
Check your understanding
Which of these is counted in this year's GDP?