GROSS DOMESTIC PRODUCT represents the BROADEST measure of the value of economic activity within a country during a period of time.
Gross Domestic Product (GDP) measures
- the market value of all final goods and services produced within the economy in a given period of time (output definition) or, equivalently,
- the aggregate income earned by all households, all companies, and the government within the economy in a given period of time (income definition).
Essentially, GDP measures the flow of output and income in the economy.
GDP can be determined in two different manners. In the income approach, GDP is calculated as the total amount earned by households and companies in the economy. In the expenditure approach, GDP is calculated as the total amount spent on the goods and services produced within the economy during a given period. For the economy as a whole, total income must equal total expenditures, so the two approaches yield the same result.
Many developed countries use a standardized methodology for measuring GDP. This methodology is described in the official handbook of the Organisation for Economic Co-Operation and Development (Paris: OECD Publishing). The OECD reports the national accounts for many developed nations. In the United States, the National Income and Product Accounts (also called NIPA, or national accounts, for short) is the official US government accounting of all the income and expenditure flows in the US economy. The national accounts are the responsibility of the US Department of Commerce and are published in its Survey of Current Business. In Canada, similar data are available from Statistics Canada, whereas in China, the National Bureau of Statistics of China provides GDP data.
To ensure that GDP is measured consistently over time and across countries, the following three broad criteria are used:
- All goods and services included in the calculation of GDP must be produced during the measurement period. Therefore, items produced in previous periods—such as houses, cars, machinery, or equipment—are excluded. In addition, transfer payments from the government sector to individuals, such as unemployment compensation or welfare benefits, are excluded. Capital gains that accrue to individuals when their assets appreciate in value are also excluded.
- The only goods and services included in the calculation of GDP are those whose value can be determined by being sold in the market. This enables the price of goods or services to be objectively determined. For example, a liter of extra virgin olive oil is more valuable than a liter of spring water because the market price of extra virgin olive oil is higher than the market price of spring water. The value of labor used in activities that are not sold on the market, such as commuting, gardening, etc., is also excluded from GDP. By-products of production processes are also excluded if they have no explicit market value, such as air pollution, water pollution, and acid rain.
- Only the market value of final goods and services is included in GDP. Final goods and services are those that are not resold. Intermediate goods are goods that are resold or used to produce another good.The value of intermediate goods is excluded from GDP because additional value is added during the production process, and all the value added during the entire production process is reflected in the final sale price of the finished good. An alternative approach to measuring GDP is summing all the value added during the production and distribution processes. The most direct approach, however, is to sum the market value of all the final goods and services produced within the economy in a given time period.
Two distinct, but closely related, measurement methods can be used to calculate GDP based on expenditures: value of final output and sum of value added. These two methods are illustrated in table below. In this example, a farmer sells wheat to a miller. The miller grinds the wheat into flour and sells it to a baker who makes bread and sells it to a retailer. Finally, the bread is sold to retail customers. The wheat and flour are both intermediate goods in this example because they are used as inputs to produce another good. Thus, they are not counted (directly) in GDP. For the purposes of GDP, the value of the final product is €1.00, which includes the value added by the bread retailer as a distributor of the bread. If, in contrast, the baker sold directly to the public, the value counted in GDP would be the price at which the baker sold the bread, €0.78. The left column of the exhibit shows the total revenue received at each stage of the process, whereas the right column shows the value added at each stage. Note that the market value of the final product (€1.00) is equal to the sum of the value added at each of the stages. Thus, the contribution to GDP can be measured as either the final sale price or the sum of the value added at each stage.