Economic Indicators

Gross Domestic Product

Noted economic analyst and forecasting guru Bernard Baumohl has called GDP “the mother of all economic indicators” (2005, 100). GDP, simply, is defined as the money value of all goods and services produced in the economy in a given year. That is, as Baumohl (100) so vividly puts it, if we add up the “total price tag” on all “hammers, cars, new homes, baby cribs, videogames, medical fees, books, toothpaste, hot dogs, haircuts, eyeglasses, yachts, kites, and computers” (100), and so on, produced during a year, the total value that we would get for this sum is the GDP. Clearly, the higher this number the better the economy is doing, since more output is better. Also, total GDP equals total national income (see later for why this is so). So as GDP increases, so does the total national income, which is good for a country.

There is one important caveat with regard to the conclusion that the higher the GDP, the higher the output, which necessitates a correction in the way GDP is computed. Normally, GDP is calculated as the value of goods and services produced in a year using the current or prevailing prices for that year. If the quantity of goods produced in the economy remain the same and if only prices rise, then the product of prices and quantities (or the values) of these goods and services and hence the sum of these values (i.e., GDP) increases as well. But this increase in total value does not really mean that the economy is producing any more output in real terms than it was producing before the prices rose. Therefore, if only prices rise, then this price rise might artificially inflate the value of GDP at an unchanged level of output. To make the measure of GDP reflect the “real” or material value of what is only actually physically produced during the current year, economists usually measure GDP at constant prices, that is, in terms of prices that prevail in a certain “base” year. With unchanged prices that are pegged to a certain year, the only way for GDP to increase is through an increase in the quantity or output. This price-change corrected measure of GDP is known as real GDP (at a certain year's prices), and this corrected measure gives a measure of actual output production in the economy. In practice, to correctly measure real changes in production, GDP deflators are constructed, which are in essence price indices that can be used to “deflate” money or “nominal” GDP figures to obtain real GDP figures. In a similar vein, we have real counterparts to many value or nominal indicators in economics (e.g., disposable income). In recent years, chain indices have been developed to convert nominal GDP to real GDP. These chained indices have the advantage that they give us the percentage changes in quantities and prices that are not tied to the choice of a specific year as a base year. These indices also help avoid several biases and distortions in the real GDP figures.

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