Gross Domestic Product

The total amount of goods and services produced, or the total amount of income earned, or the total amount of expenditure undertaken, all tell us something about the overall performance of the economy in providing resources for the members of the society. If we could measure these totals, we could examine whether the resources available to the residents of a country were changing through time, or try to compare the country’s situation with that in other nations. Of course, there is such a measure. It is called GDP and it is a key way in which we try to monitor the performance of an economy.

Here is a definition of GDP:

Gross domestic product (GDP) is the market value of all final goods and services produced within a country in a given period of time. Let's consider each phrase in this definition with some care.

" GDP is a Market Value...". GDP adds together many different kinds of products into a single measure of the value of economic activity. To do this, it uses market prices. Because market prices measure the amount people are willing to pay for different goods, they reflect the value of those goods.

" Of All..." GDP tries to be comprehensive. It includes all items produced in the economy and sold legally in markets. GDP excludes items produced and sold illicitly, such as illegal drugs. It also excludes most items that are produced and consumed at home and, therefore, never enter the marketplace.

" Final..." GDP includes only the value of final goods. The reason is that the value of intermediate goods is already included in the prices of the final goods. Adding the market value of the intermediate goods to the market value of the final goods would be double counting.

" Goods and Services..." GDP includes both tangible goods (food, clothing, cars) and intangible services (haircuts, housecleaning, doctor visits).

" Produced..." GDP includes goods and services currently produced. It does not include transactions involving items produced in the past. When General Motors produces and sells a new car, the value of the car is included in GDP. When one person sells a used car to another person, the value of the used car is not included in GDP.

" Within a Country..." GDP includes the market value of the goods produced domestically, regardless of the nationality of the producer. When a Canadian citizen works temporarily in the United States his production is part of U.S. GDP. When an American citizen owns a factory in Haiti, the production at his factory is part Haiti's GDP.

" … In a Given Period of Time." GDP measures the value of production that takes place within a specific interval of time. Usually that interval is a year or a quarter (three months). GDP measures the economy's flow of income and expenditure during that interval. When the government reports the GDP for a quarter, it usually presents GDP “at an annual rate”, which means that the data have been modified by a statistical procedure called seasonal adjustment.

Economists distinguish between nominal GDP and real GDP. Nominal GDP is the value of all final goods based on the prices existing during the time period of production. Real GDP is the value of all final goods produced during a given time period based on the prices existing in a selected base year. In other words, the prices in the base year provide the basis for comparing quantities in different years.

As we have just seen, nominal GDP reflects both the prices of goods and services and the quantities of goods and services the economy is producing. By contrast, by holding prices constant at base-year levels, real GDP reflects only the quantities produced. From these two statistics, we can compute a third called the GDP deflator, which reflects the prices of goods and services but not the quantities produced. The GDP deflator is calculated as follows: