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What Is
Gross Domestic
Product?
Tim Callen
M
any professions commonly use acronyms. Moreover, “gross” domestic product takes no account of
To doctors, accountants, and baseball players, the wear and tear on the machinery, buildings, and so on (the
the letters MRI (magnetic resonance imaging), so-called capital stock) that are used in producing the out-
GAAP (generally accepted accounting princi- put. If this depletion of the capital stock, called depreciation,
ples), and ERA (earned run average), respectively, need no ex- is subtracted from GDP, we get net domestic product.
planation. To someone unfamiliar with these fields, however, Theoretically, GDP can be viewed in three different ways.
without an explanation these acronyms are a stumbling block • The production approach sums the “value added” at
to a better understanding of the subject at hand. each stage of production, where value added is defined as
Economics is no different. Economists use many acro- total sales minus the value of intermediate inputs into the
nyms. One of the most common is GDP, which stands for production process. For example, flour would be an inter-
gross domestic product. It is often cited in newspapers, on mediate input and bread the final product, or an architect’s
the television news, and in reports by governments, central services would be an intermediate input and the building the
banks, and the business community. It has become widely final product.
used as a reference point for the health of national and global • The expenditure approach adds up the value of pur-
economies. When GDP is growing, especially if inflation is chases made by final users—for example, the consumption
not a problem, workers and businesses are generally better of food, televisions, and medical services by households; the
off than when it is not. investments in machinery by companies; and the purchases
of goods and services by the government and foreigners.
Measuring GDP • The income approach sums the incomes generated by
GDP measures the monetary value of final goods and production—for example, the compensation employees
services—that is, those that are bought by the final user—pro- receive and the operating surplus of companies (roughly
duced in a country in a given period of time (say a quarter or sales minus costs).
a year). It counts all the output generated within the borders GDP in a country is usually calculated by the national sta-
of a country. GDP is composed of goods and services pro- tistical agency, which compiles the information from a large
duced for sale in the market and also includes some nonmar- number of sources. In making the calculations, however,
ket production, such as defense or education services provid- most countries follow established international standards.
ed by the government. An alternative concept, gross national The international standard for measuring GDP is contained
product, or GNP, counts all the output of the residents of a in the System of National Accounts, 1993, compiled by the
country. So if a German-owned company has a factory in the International Monetary Fund, the European Commission, the
United States, the output of this factory would be included in Organization for Economic Cooperation and Development,
U.S. GDP, but in German GNP. the United Nations, and the World Bank.
Not all productive activity is included in GDP. For example,
unpaid work (such as that performed in the home or by vol- Real GDP
unteers) and black-market activities are not included because One thing people want to know about an economy is whether
they are difficult to measure and value accurately. That means, its total output of goods and services is growing or shrinking.
for example, that a baker who produces a loaf of bread for a But because GDP is collected at current, or nominal, prices,
customer would contribute to GDP, but would not contribute one cannot compare two periods without making adjust-
to GDP if he baked the same loaf for his family. ments for inflation. To determine “real” GDP, its nominal