Measuring the Economy 1

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Gross Domestic Product (GDP)

The Gross Domestic Product measures the value of economic activity within a country. Strictly defined, GDP is the sum of the market values, or prices, of all final goods and services produced in an economy during a period of time. There are, however, three important distinctions within this seemingly simple definition:

1. GDP is a number that expresses the worth of the output of a country in local currency.
2. GDP tries to capture all final goods and services as long as they are produced within the country, thereby assuring that the final monetary value of everything that is created in a country is represented in the GDP.
3. GDP is calculated for a specific period of time, usually a year or a quarter of a year.
Taken together, these three aspects of GNP calculation provide a standard basis for the comparison of GDP across both time and distinct national economies.

Computing GDP

Now that we have an idea of what GDP is, let's go over how to compute it. We know that in an economy, GDP is the monetary value of all final goods and services produced. For example, let's say Country B only produces bananas and backrubs.

Figure %: Goods and Services Produced in Country B
In year 1 they produce 5 bananas that are worth \$1 each and 5 backrubs that are worth \$6 each. The GDP for the country in this year equals (quantity of bananas X price of bananas) + (quantity of backrubs X price of backrubs) or (5 X \$1) + (5 X \$6) = \$35. As more goods and services are produced, the equation lengthens. In general, GDP = (quantity of A X price of A) + (quantity of B X price of B) + (quantity of whatever X price of whatever) for every good and service produced within the country.

In the real world, the market values of many goods and services must be calculated to determine GDP. While the total output of GDP is important, the breakdown of this output into the large structures of the economy can often be just as important. In general, macroeconomists use a standard set of categories to breakdown an economy into its major constituent parts; in these instances, GDP is the sum of consumer spending, investment, government purchases, and net exports, as represented by the equation:

Y = C + I + G + NX
Because in this equation Y captures every segment of the national economy, Y represents both GDP and the national income. This because when money changes hands, it is expenditure for one party and income for the other, and Y, capturing all these values, thus represents the net of the entire economy.

Let's briefly examine each of the components of GDP.

• Consumer spending, C, is the sum of expenditures by households on durable goods, nondurable goods, and services. Examples include clothing, food, and health care.
• Investment, I, is the sum of expenditures on capital equipment, inventories, and structures. Examples include machinery, unsold products, and housing.
• Government spending, G, is the sum of expenditures by all government bodies on goods and services. Examples include naval ships and salaries to government employees.
• Net exports, NX, equals the difference between spending on domestic goods by foreigners and spending on foreign goods by domestic residents. In other words, net exports describes the difference between exports and imports.

GDP vs. GNP

GDP is just one way of measuring the total output of an economy. Gross National Product, or GNP, is another method. GDP, as said earlier, is the sum value of all goods and services produced within a country. GNP narrows this definition a bit: it is the sum value of all goods and services produced by permanent residents of a country regardless of their location. The important distinction between GDP and GNP rests on differences in counting production by foreigners in a country and by nationals outside of a country. For the GDP of a particular country, production by foreigners within that country is counted and production by nationals outside of that country is not counted. For GNP, production by foreigners within a particular country is not counted and production by nationals outside of that country is counted. Thus, while GDP is the value of goods and services produced within a country, GNP is the value of goods and services produced by citizens of a country.

For example, in Country B, represented in , bananas are produced by nationals and backrubs are produced by foreigners. Using figure 1, GDP for Country B in year 1 is (5 X \$1) + (5 X \$6) = \$35. GNP for country B is (5 X \$1) = \$5, since the \$30 from backrubs is added to the GNP of the foreigners' country of origin.