GDP: Gross Domestic Product

While microeconomics deals with decisions made by smaller units such as individuals and businesses, macroeconomics is the branch of economic theory dealing with the economy as a whole and decision making by large units such as governments and unions. It deals with the economy as a whole, and measures output, income, prices and employment. One of the most important measures of the economy on a macro scale is Gross Domestic Product. The gross domestic product or GDP, is arguably the most important indicator on the health of a country's economy.

GDP measures the total value of all goods and services produced in an economy within a one year period, and within the country's national border. If you see in the news that the economy grew by 2.3% in a particular year, they are talking about GDP growth. This indicates that the country produced 2.3 more goods and services than they did the year before. GDP really only measures one thing -- money. More to the point, GDP measures the money being made by the interaction of production and consumption in an economy. It's everything produced by people and businesses, including salaries of workers.

In order to measure GDP, you would multiply all of the final goods and services produced in a 12-month period by their prices and then add them up to get the total dollar value of production. The different product categories includes Goods, Services and Structures (residential housing, apartments, and buildings for commercial purposes). It is impossible to record every good and service, so government statisticians instead use scientific sampling techniques to estimate the quantities and prices of individual products. To keep current, they measure every quarter. They could also calculate by adding up what everyone earned in a year, or by adding up what everyone spent; both should yield about the same results.

There are four things excluded from GDP calculations. These five are:

1. Intermediate products - goods used to make other products already counted in GDP. If you buy new replacement tires for your car, these tires are counted in GDP. However, whenever you buy a new car, the tires on the car were combined with other parts to make a new part. Therefore they are not counted separately because their value is already built in with the price of the new car.
2. Secondhand Sales - the sales of used goods. These are not included because no new production is created when products already in existence are transferred from one owner to another.
3. Nonmarket Transactions - economic activities that do not generate expenditures in the market. GDP does not take into account the value of your services when you mow your own lawn or do your own home repairs/chores.
4. Underground Economy - activities that are not reported for legal or tax collection purposes. Some of these are illegal activities, such as with gambling, smuggling, and drug deals. Some activities are legal, such as those at a flea market, farmers' markets, garage sales, craigslist sales or when a babysitter is hired for a few hours, but these are hard to trace because a simple cash transaction is made.

GDP can appear to increase whenever prices go up. For example, the quantity of products produced can stay the same, yet the price can increase, which would then increase overall GDP. Because of this, GDP is then adjusted for inflation. In order to perform this calculation, economists use a set of constant prices in a base year, which is a year that serves as the basis comparison for all other years. For instance, if GDP is calculated using only prices from 2005, then any increases would strictly be due to changes in the quantity of products/services/infrastructure produced, not by price. Using this method to measure GDP is known as real GDP, or GDP measured after adjustments for inflation.

On the other side, current GDP (also known as GDP, nominal GDP, or current price GDP), is measured without any adjustments made for inflation. In these calculations, output in any given year was measured using the prices that existed in those years. If GDP climbs 10%, but inflation is also 10%, we haven't produced more of anything, just sold the same amount of stuff at higher prices. Standard of living depends on the quantity of goods and services we take home with us, not on the price that shows up at the register.

Often, we want to adjust GDP for population to help prevent any misleading conclusions. GDP per capita is simply a nation's GDP divided by population. It is the GDP on a per person basis and can be expressed in current or constant dollars. If we compare the GDP for India with Israel, it would appear that India is doing much better. India has a GDP of $3.3 trillion and Israel only has a GDP of $201 billion. However, Israel is actually the richer country because they only have a population of 7 million while India has more than a billion. This would then make Israel's GDP per capita, $28,300, and India's GDP per capita only $2,900. If a country's economy grows 3% in a year but the population grows 5%, then GDP per capita will actually fall. The country is producing more goods and services but not enough more to keep up with a population that is growing faster

A recession occurs when there is a decline in real GDP lasting at least two quarters or more. It begins when the economy reaches a peak, or a point where real GDP stops going up. It then ends when the economy hits a trough, which is a turnaround point where real GDP stops going down. In the US, we have faced a handful of recessions, but one of the most recent started in 2007 with the housing market bubble. If any recession becomes very severe, it may turn into a depression, which is a state where the economy sees a large number of people out of work, acute shortages, and excess capacity in manufacturing plants. The only depression experienced in the US was the Great Depression of the 1930's.

As stated before, GDP is arguably the most important indicator on the health of a country's economy. However, it still comes with limitations. It does not tell us anything about the composition of output, and it tells little about the impact of production on quality of life. Finally, some GDP is produced to control activities that give us little utility or satisfaction, however it makes GDP higher. The money spent to fight crime would increase GDP, but if we had less crime, then we would have a smaller GDP because the government is spending less to control the crime. Even though this would make GDP smaller, it would actually leave us better off.

Due to various limitations, some economists have developed alternative means of measuring the well-being of a country. One measure is the Human Development Index(HDI), which is adding in overall well-being into GDP, or a composite statistic of life expectancy, education, and per capita income indicators. The HDI was created to emphasize that people and their capabilities should be the ultimate criteria for assessing the development of a country, not economic growth alone.

Student Activity:

• Article: The Trouble with GDP (see below)
• Questions are in notes

Sources

• http://money.howstuffworks.com/gross-national-happiness.htm/printable
• http://visual.ly/gross-domestic-product-explained
• http://www.cnbc.com/id/44505017
• http://hdr.undp.org/en/content/human-development-index-hdi