Gross Domestic Product: An Economy’s All

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When GDP is growing, especially if inflation is not a problem, workers and businesses are generally better off than when it is not.

GDP measures the monetary value of final goods and services produced in a country in a given period of time (for example, a quarter or a year).
GDP counts output generated within the borders of a country and includes:
- goods and services produced for sale in the market; and
- some nonmarket production (for example, defense or education services provided by the government).
Gross national product (GNP) differs by counting output of residents of a country; e.g., output of a German-owned factory in the United States is included in U.S. GDP but in German GNP.
Exclusions from GDP:
- unpaid work (such as household work or volunteer services);
- black-market activities.
“Gross” does not subtract depreciation (wear and tear on capital stock). Subtracting depreciation yields net domestic product.

Three theoretical approaches to GDP:
- Production approach: sums “value-added” at each stage of production (value-added = total sales less value of intermediate inputs).
- Expenditure approach: adds purchases by final users (household consumption, business investment, government purchases, and foreigners).
- Income approach: sums incomes generated by production (compensation of employees and operating surplus of companies).

Measurement standards:
- National statistical agencies compile GDP following established international standards.
- The international standard is contained in the System of National Accounts, 1993, compiled by the IMF, the European Commission, the Organization for Economic Cooperation and Development, the United Nations, and the World Bank.

Nominal GDP is collected at current prices; to compare different periods, adjust for inflation to obtain “real” GDP using a price deflator to convert to constant prices.
The growth rate of real GDP is often used as an indicator of the general health of the economy.
Relationships and dynamics:
- When real GDP is growing strongly, employment is likely to increase.
- When GDP is shrinking, employment often declines.
- GDP growth may be insufficient to create enough jobs even when positive.
- Real GDP growth moves in cycles: booms and periods of slow growth or recession.
- Recession often defined as two consecutive quarters during which output declines.
- Example: In the United States, there were six recessions of varying length and severity between 1950 and 2011.
- The National Bureau of Economic Research determines U.S. business cycle dates.

GDP is measured in domestic currency; comparisons require conversion to a common currency (commonly U.S. dollars).
Two conversion methods:
- Market exchange rates (foreign exchange market rates).
- Purchasing power parity (PPP) exchange rates: the rate at which one currency would have to be converted to purchase the same basket of goods and services in each country.
Observations:
- For most emerging market and developing countries, the ratio of the market and PPP U.S. dollar exchange rates is between 2 and 4.
- Nontraded goods and services tend to be cheaper in low-income than in high-income countries (example: a haircut in New York vs. Bishkek).
- For advanced economies, market and PPP exchange rates tend to be much closer.
- Using PPP exchange rates typically yields a higher estimated dollar GDP for emerging market and developing countries.
IMF practices:
- The IMF publishes an array of GDP data on its website (www.imf.org).
- Global and regional real GDP growth aggregates are constructed as weighted averages of individual-country GDPs, with weights reflecting each country’s share of GDP in the group (with PPP exchange rates used to determine weights).

GDP is not a measure of overall standard of living or well-being.
Limitations include omission or poor capture of:
- environmental damage and other external costs (for example, noise);
- depletion of nonrenewable natural resources;
- changes in leisure time;
- distributional aspects of GDP among residents.
Alternatives and supplements:
- United Nations Human Development Index (ranks countries using GDP per capita plus life expectancy, literacy, school enrollment).
- Other attempts: Genuine Progress Indicator; Gross National Happiness Index — each has critics.

Article: F&D Magazine — TIM CALLEN, Back to Basics

Gross Domestic Product: An Economy’s All
- Gross Domestic Product: An Economy’s All (Markdown version)
- Gross Domestic Product: An Economy’s All (PDF)