Gross Domestic Product (GDP)

The Economic Dimension of the Gross Domestic Product

In the GDP, all the goods and services produced are aggregated in terms of value, that is, in terms of the prices paid by the buyers. Because some goods are used to produce other goods (e.g., the steel used in the production of automobiles), adding up the value of all the products would lead to “double counting” (the steel would be counted twice, once as a product of the steel industry and again as part of the value of the automobiles). To avoid that, only “final” goods are taken into account, that is, goods that are not used in the production of other goods (in our example, the automobiles, but not the steel). Alternatively, we can add up the “value added” by each production unit (the value the steel company adds to the raw materials, supplies, and energy purchased from other companies; and the value the auto maker adds to the value of the raw materials and supplies obtained from other industries, etc.).

The GDP is calculated, as we said, using the selling prices in the period in question. Therefore, to compare the GDPs of two different periods we need to separate the change in physical output from any mere change in prices. To do that, we calculate the GDP in real terms, that is, in the prices of a given year (known as the base year, which tends to be the previous year). That effectively eliminates any change due solely to changes in prices. And as the size of a country's GDP will depend on the amount of production factors available, it is useful to calculate GDP per capita (total GDP divided by the country's population) as a measure of the volume of the income generated by one person in the country.

As we have seen, the GDP contains information about the scale and composition of a country's production, the income it generates, the size and makeup of its citizens' spending (in other words, the standard of living of its population), employment creation, and how these variables have changed over time. It also allows us to compare the economies of different countries, although this raises at least two further problems. One is what common currency to use for the comparison, because any changes in the exchange rate of the chosen currency may give rise to spurious changes in our comparisons of the GDP. The other is the fact that the purchasing power of the same monetary unit may be very different in different countries: Although one dollar is one dollar, whether in the United States or in India, you can buy a lot more with one dollar in New Delhi than you can in New York. For that reason, international comparisons tend to be made in terms of what one could purchase in each country with a certain amount of money, which corrects that effect.

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