Gross Domestic Product

What It Means

Gross domestic product (GDP) is a figure that represents the total value of all goods and services produced in a country in a given time period. More simply, it is a measure of the total size of an economy. In the United States, government economists calculate GDP every quarter (in the financial world, each year is commonly broken down, for purposes of analysis, into four three-month periods called quarters), as well as yearly. GDP is generally considered one of the most important measurements of a country’s economic health. Therefore, it is used by government officials as an aid in creating policies, by business leaders in making business decisions, and by economists to improve their understanding of the economy.

In order to avoid counting certain goods (those that are part of other goods) multiple times, GDP measures only what are known as final products, or products that are sold to consumers on the open market. For instance, the plastic used to make a laptop computer might be made in the United States and sold in the United States to a computer manufacturer, but economists use only the sale of the computer itself when they calculate GDP. If they included the sale of the plastic to the manufacturer as well as the sale of the computer to the consumer, they would be counting the value of the plastic twice.

When Did It Begin

GDP represents both a refinement of and an alternative to a similar measure of economic health called gross national product (GNP). GNP also measures the total value of goods and services produced in a country during a given period of time, but GNP is calculated using a different approach to the U.S. business activity of foreign citizens and to the foreign business activity of U.S. citizens. The statistics yielded by both calculations are typically very similar in countries with developed economies.

The concept of GNP was developed in the 1930s by a Ukrainian-born U.S. economist named Simon Kuznets (1901–85; Kuznets won the Nobel Prize in 1971, in part for work related to the concept of GNP). The U.S. government, reeling from the effects of the Great Depression, was in search of a way of measuring the country’s economic problems. Kuznets’s idea of calculating the value of only final products provided a sorely needed way of measuring economic health and growth accurately, and it became a standard economic indicator (a statistic that reflects the health of the economy) in countries around the world. In the early 1990s the U.S. government began using GDP rather than GNP in its assessments of economic health, though GNP is still widely applied as well.

More Detailed Information

GDP is generally arrived at by using a formula that adds together the monetary value of products in four different economic categories: consumer spending, investment, government spending, and net exports. Household purchases fall into the category of consumer spending; purchases made by businesses come under the category of investment; government spending refers to purchases made by the government; and purchases of American-made products by citizens of other countries (minus U.S. purchases of imports, which are excluded from the calculation of GDP) make up net exports. Because these four categories include all of the major kinds of purchases of U.S. goods and services, GDP can be thought of as a measure of the total national income.

When the GDP is rising, a national economy is growing. In the United States GDP increases of 3 to 5 percent each year are considered optimal. These figures indicate that the economy is growing at a healthy, sustainable rate (a rate that can be kept up). GDP increases of 2 percent and below are considered sluggish. A recession (a time of economic decline less severe than a depression) is generally defined by the shrinking of the GDP for two straight quarters.

Government officials depend on GDP to judge the rate at which the economy is growing; they use it to determine the future course of economic and other policies. For instance, a U.S. president or Congress might use sluggish GDP figures as a reason to lower taxes, a strategy that is believed to promote economic growth; or a nation’s central bank (an agency of the government responsible for overseeing the money supply) might see rapid increases in GDP as a reason to restrain economic growth by raising key interest rates (the fees borrowers pay to institutions that loan money).

Similarly, business executives in a variety of private industries look to GDP as a way of predicting economic activity in the future. An executive trying to decide whether or not to invest in new factories, for example, might be more likely to do so if the rate of overall economic growth (as measured by GDP) is strong. Financial professionals and investors, likewise, might pay close attention to GDP numbers (along with other economic data) when determining whether to buy stocks and bonds at any given moment.

Economists, meanwhile, rely on GDP figures in improving their theories about how economies develop and behave. A record of GDP growth and declines during the past three decades in the United States, for instance, might provide crucial insights into how the national economy has evolved from one based primarily on manufacturing to one increasingly dependent on service industries (forms of business activity dealing with human services rather than physical goods).

Still, while government officials and other analysts may point to a high GDP as evidence a society’s economic vitality, it can sometimes be misleading to equate this particular measure of economic size with a country’s or region’ overall economic well-being or standard of living. Consider, for example, the economic consequences of one of the biggest environment disasters in U.S. history. In 1989 the Exxon Valdez oil tanker ran aground in Alaska, dumping more than 11 million gallons of crude oil into its pristine Prince William Sound. The spill generated so much spending for cleanup-up efforts (Exxon claimed to have spend more than $2.1 billion on the project during the next few years), media coverage, and law suits that it led directly to a rise in Alaska’s GDP. This rise masked the lasting environmental damage to Price William Sound and the crippling of the region’s fishing industry, one of its main sources of income. This example points out that while the GDP is a valuable measure of the size of an economy, it does not a describe what is in the economy, nor does it necessarily reflect the quality of life the economy provides. Another limitation of the GDP is that it does not include certain types of economic exchange—for example, the black market (such as drugs, prostitution, and illegal weapons), bartering (goods and services that are traded, not bought or sold), and work done without pay, such as volunteering at the local humane society or even helping a friend move. Conversely, it does not measure positive aspects of a society that have no easily assigned monetary value, such as healthy children, clean water, ecological diversity, and close-knit neighborhoods.

Recent Trends

GDP is likely to remain one of the chief tools economists and government officials use for evaluating economic health both in a given country and in relations between countries. One particularly useful way of comparing the economic health of different nations is by calculating per capita GDP: the measure of income produced by a national economy per citizen (the dollar figure divided by the number of citizens). The reason that the per capita figure is more meaningful than total GDP in some cases is that two countries may have the same GDP, but one of the countries may have a far higher population. In this case per capita GDP differs greatly. For instance, imagine two economies, both with a GDP of $100, but one has 2 citizens and the other has 10 citizens. The first economy would have a per capita GDP of $50, and the second would have a per capita GDP of $10.

Per capita GDP tends to correspond to many other statistics about a country, such as access to medical care, the infant mortality rate (the percentage of infants that die), and life expectancy (the number of years the average person lives). In the United States in 2005, per capita GDP stood at almost $42,000. Per capita GDP in most western European countries was somewhat lower but still comparable. For example, France and Germany both had a per capita GDP of roughly $30,000. The split between such developed economies and developing economies, like those of China and India, is extreme. China and India have larger total GDPs than France or Germany, but in 2005 China’s per capita GDP was just under $7,000, and India’s was around $3,000. Meanwhile, the per capita GDP of Afghanistan was well below $1,000.