Gross Domestic Product (gdp)

Gross Domestic Product (GDP)

Macroeconomists are interested in total production in the economy, so it is essential that we create a measure of total output. This measure is called GDP. GDP is the total market value of all final goods and sevices produced in a country in a given year. Three things to note about this definition of GDP:

* total market value. We add up the dollar value of all the stuff produced in the United States. This is because producing a car is way different that producing a haircut or a can of soup, but by converting everything to its dollar value we have a uniform measure.

* final goods and services. We only count final products ready to be consumed, NOT products used to make other products. So a car will be counted in the GDP but the steel used to make the car is not counted separately. Why? Because the value of the car already reflects the value of the steel, rubber, plastic,etc. that goes into it.

* produced in a country. The U.S. GDP counts only those goods and services produced in the physical borders of the United States. So Toyotas made in Ohio are counted, even though Toyota is a Japanese company. However, minivans made by General Motors in Mexico do NOT count in GDP, even though GM is a U.S. company. Where the good or service is produced is important.

Nominal GDP vs. Real GDP

In measuring GDP, we use prices to measure the value of good and services produced. Using the current prices to value current production is known as nominal GDP. The problem with nominal GDP is that a change in nominal GDP can be due to either (1) a change in the production of goods and services, or (2) a change in the prices of those goods and services. So an increase in prices will cause nominal GDP to rise, even if production has not changed at all. This gives a misleading picture of how well our economy is doing. It also makes it difficult to compare production from year to year, since prices change every year.

To address the price problem, we also construct a measure of GDP that takes price changes into account. Real GDP values goods and services in any given year by using the prices of a set base period. By holding prices constant, real GDP measures only the changes in production from year to year. Changes in real GDP are used to measure economic growth.

What does GDP NOT measure?

So GDP is an important measure of the economic power and health of a nation. But GDP does not tell the whole story in terms of the well being of a nation. Here are a few things GDP leaves out:

* Other social indicators. These include crime, illiteracy, life expectancy, infant mortality. Although these things are related to GDP, the connection is not perfect: The U.S. has a larger GDP per capita than Canada or Japan, but also has a higher rate of crime, illiteracy, and infant