Gross Domestic Product (GDP)

In macroeconomics, the most common way economists and policymakers measure the health of an overall

economy is by examining gross domestic product, or GDP. Gross means total, domestic means within

a country’s borders, and product means the value of all goods and services produced. However,

that’s a bit of an oversimplification, so let’s look at the complete definition.

Gross domestic product is the value of all final goods and services produced within a

country’s borders in a given year. Note the emphasis on “final” and “in a given year.”

Final goods are also called “finished goods.” A final good is one that will not be sold again as

part of some other good. If a baker buys flour, sugar, and butter, we don’t count those as final

goods, because the baker will use those goods to make a cake. In other words, they are goods that

aren’t finished yet, they are intermediate goods. Now, the cake the baker made using that flour,

sugar, and butter, is a final good since the cake is the final product, and its final destination is

the consumer. In other words, a customer will buy it and consume it. There are also goods that are

used to make other goods but are still considered final goods. These are called “capital goods.”

For example, if a farmer buys a combine to harvest his crops, the combine is considered a final good.

Even though the combine is used to produce other goods, it won’t be sold again as part of another

good. There are also capital goods used to provide services counted as final goods. For example, if a

landscaper buys a chainsaw in order to take down trees, the chainsaw is considered a final good.

GDP also only counts production in a given year. If an old car is sold this year,

economists don’t count it as part of GDP since the car wasn’t produced this year. They only

count new cars sold this year as part of GDP. Also, production is only counted if the good or

service is produced within a country’s borders. For example, if you are in the United States and

buy a shirt imported from Vietnam, that adds to Vietnam’s GDP, not the United States GDP. But a

movie made in the United States that is shown in theaters in Vietnam adds to the United States GDP.

It’s helpful to think of the entire economy of a country as one big hypermarket store,

meaning they sell pretty much everything you could possibly ever want to buy. Not just products like

food and clothing, but also services like pet grooming and tax preparation. Every time a

consumer buys a final good or service, we record the cost, just like at a cash register. All the

cost combined over a given year is the GDP. Government economists often divide final

goods and services into four categories. Consumer goods and services, business goods and services,

government goods and services, and net exports. Net exports are found by simply adding up exports

and subtracting imports. Government economists can also calculate GDP using another method. Instead

of adding up all the stuff that consumers, businesses, and the government buys, it can

add up all the incomes in the economy. There is also nominal GDP and real GDP. Nominal GDP is

measured in current prices. Real GDP is measured in constant, or unchanging prices. In other words,

real GDP is nominal GDP but adjusted for inflation. Real GDP is a more accurate way

to measure economic growth, since inflation can distort the actual value of goods and services.

However, GDP is not a perfect way to assess the health of a country’s economy. First of all, GDP

doesn’t take into account many things that could be considered part of an economy. For example,

it doesn’t measure non-market activities, or goods and services that people make or do themselves,