Measuring the Size of the Economy: Gross Domestic Product
Macroeconomics is an empirical subject, meaning that it is verifiable by observation or experience rather than theory. Given this, the first step toward understanding macroeconomic concepts is to measure the economy. (6)
How large is the U.S. economy? The size of a nation’s overall economy is typically measured by its Gross Domestic Product (GDP) , which involves counting up the production of millions of different goods and services — houses, cars, smart phones, computers, steel, oranges, college educations, and all other new goods and services produced in the current year — and summing them into a total dollar value.
GDP measures the market value of the goods, services, and structures produced by the nation’s economy in a particular period. GDP is one of the most comprehensive and closely watched economic statistics; It is used by the White House and Congress to prepare the Federal budget, by the Federal Reserve to formulate monetary policy, by Wall Street as an indicator of economic activity, and by the business community to prepare forecasts of economic performance that provide the basis for production, investment, and employment planning. While GDP is used as an indicator of economic activity, it is not a measure of well-being (for example, it does not account for rates of poverty, crime, or literacy). (7)
GDP is equal to the total expenditures for all final goods and services produced within the country in a stipulated period of time. According to the Bureau of Economic Analysis (BEA), in 2015 the U.S. GDP totaled about $18 trillion in current dollars, and about $16.4 trillion in chained 2009 dollars, which represents the largest level of GDP among all countries in the world. (8)
Each of the market transactions that enter into GDP must involve both a buyer and a seller. The GDP of an economy can be measured either by the total dollar value of what is purchased in the economy (the Income Approach), or by the total dollar value of what is produced (the Expenditure Approach). (6)
Definition of the GDP: Breaking Things Down
At its core, the gross domestic product (GDP) measures how much output a country’s economy has produced in a stipulated period of time. Because adding up different goods and services, measured in different measurement units, is not a practical way to measure production in the economy, economists rely on the market value of goods and services produced. Thus, GDP represents the market value (expressed in a country’s currency, such as the dollar) of all final goods and services legally produced within a country in a given time period, typically one year.
In a nutshell, such measurement involves the calculation of market value , which for each unique good or service produced consists of multiplying its quantity with the market price, followed by adding everything up into an overall dollar figure. In practice, the process is much more complicated and involves NIPA accounts for thousands of goods and services. For a deeper understanding of NIPA accounts, see: https://www.bea.gov/national/pdf/nipa_primer.pdf
The following are several points to keep in mind when considering the output of the economy:
- Production , not sales , within a given time period (typically one year) is what GDP captures. Not all output produced in a year is sold that year. The unsold output becomes inventory. On the other hand, if a car produced last year was only sold this year, it will be counted in last year’s GDP, when it was first produced, and became inventory (last year).
- In addition to market production , GDP includes some nonmarket production . GDP is composed of goods and services, which are produced for sale in the market, and of nonmarket goods and services, which are not sold in the market, such as: the defense services provided by the federal government, the education services provided by local governments, the emergency housing or health care services provided by nonprofit institutions serving households (such as the Red Cross), and the housing services provided by and for persons who own and live in their home (referred to as “owner-occupants”). However, not all productive activity is included in GDP. In particular, because data are not available to accurately measure their value, the following activities are NOT included in GDP:
- Care of one’s own children
- Uunpaid volunteer work for charities
- Illegal activities (7)
- Whenever possible, GDP is valued at market prices . The NIPAs value market goods and services using prices set by the market. This approach provides a common unit of measurement (dollars) that facilitates comparisons of the various goods and services that make up economic activity. Using market values also facilitates the analysis of the impact of events on the economy, such as the implementation of government programs or the occurrence of natural disasters. (7)
- The reason why only final goods and services are included in the calculation of GDP is to avoid double counting. A final or finished good or service is a good or service that is produced for its final user, unlike an intermediate good or service, which is a good or service that is used as a component of a final good or service.
- Only legally produced goods and services are counted in the GDP.
- The word ” domestic ” in Gross Domestic Product pertains to the fact that only the goods and services produced within a countryare counted in the GDP. So, a Toyota Tundra produced in Texas is counted in the U.S. GDP, and a Chevy Silverado produced in Silao, Mexico is not counted in the U.S. GDP.
- GDP measures production during a given period of time, typically one year. In the U.S., quarterly GDP data exist, but this is not the case in other countries. Production of a good or service produced in a previous time period (even if perhaps sold in the present time period) does not count in this period’s GDP. (1)