1 Measuring Economic Output

What GDP measures

Gross domestic product (GDP) measures the market value of final goods and services produced within a country’s borders during a specified period, such as a quarter or a year. It is a broad measure of economic production. “Domestic” refers to where production takes place, not who owns the producer: production at a factory located in the United States counts in U.S. GDP even if the factory is foreign-owned.

GDP includes production by households, businesses, and government. It counts final goods and services—those bought for final use—so that the same production is not counted more than once. If a mill sells flour to a bakery and the bakery uses it to make bread sold to a customer, GDP counts the bread’s final sale, not the flour separately; the flour’s value is reflected in the bread’s price.

The components of GDP

One common way to organize U.S. GDP is:

Here, $C$ is consumer spending, $I$ is investment in productive assets and inventories, $G$ is government purchases of goods and services, and $X - M$ is exports minus imports. Imports are subtracted because GDP measures production within the country, not goods and services produced abroad.

What GDP leaves out

GDP is useful for tracking the scale and direction of measured production, but it does not include every activity that contributes to people’s lives and is not a complete measure of well-being.

Some valuable work is generally excluded because it is not exchanged in a market and is difficult to value consistently. Examples include unpaid household work, such as caring for one’s own children, and volunteer work. Some nonmarket services are included: government services are often valued by their production costs.

GDP does not show how income or output is distributed. A country’s GDP can rise even if gains go mainly to a small share of its population. Nor is GDP a direct measure of quality of life: it does not by itself show health, leisure, safety, poverty, or environmental quality. Production that causes pollution may increase GDP even though GDP does not directly subtract the costs created by that pollution.

Current production and transactions

GDP concerns current production. A sale of a used car generally does not count as new production, although a fee for a newly provided service related to the sale may count. Buying a financial asset, such as a share of stock, is also not itself production of a new good or service.

GDP is therefore useful for measuring economic activity, but it should not be treated as a complete scorecard for society.

Nominal and real GDP

Nominal GDP, also called current-dollar GDP, values production using the prices of the period being measured. It can increase because the economy produces more, because prices rise, or both.

Real GDP adjusts for changes in prices, making it more useful for comparing the volume of production across time. For example, if the total dollar value of goods and services rises by $5\%$ while the overall price level also rises, nominal GDP has grown, but real GDP growth will be lower. Real GDP is an estimate that removes the effects of price changes; it is not simply a count of physical items, since goods and services vary in type and quality.

Calculating GDP growth

GDP growth is the percentage change in GDP from one period to another. To assess whether the amount of production has grown, economists usually focus on the percentage change in real GDP:

For example, if real GDP rises from $\$1{,}000$ billion to $\$1{,}020$ billion, the growth rate is $2\%$. A positive rate indicates increased measured production; a negative rate indicates decreased production over the period. GDP figures can be revised as more information becomes available, so an initial estimate may change.