Gross Domestic Product
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GDP is the amount of all goods and services produced in a given country within a given period of time.
GDP measures a country’s total output. Since (almost) all that is produced in an economy is eventually bought and turned into income, GDP also measures the amount of income earned in a country for a given period of time.
- How is GDP used?
- GDP measures how big a nation is in economic terms.
- GDP per capita is often used to compare the welfare of different countries. Because GDP is also a measure of income, GDP per capita gives an idea of how wealthy the people are on average for a given country. (note: per capita means that you divide total GDP by the number of people in the country)
- The speed at which GDP grows determines how fast an economy is growing and how healthy the economy is. Higher growth most often means that the economy is strong. If the growth rate of GDP for a country were negative, that country is producing less this year than it did the previous year and the country is in what is called a recession.
- The growth rate is calculated as the percentage change in GDP from one time period to the next
The following graph demonstrates the growth rate of GDP for the U.S. and the EU since 1993:
- How is GDP measured?
- The most common way to measure GDP is called the expenditure approach. This approach measures GDP by looking at the amount of new goods and services purchased in a country for a given year. A simple equation is used: Y = C + I + G + NX
- Let’s take Belgium in 2007 as an example. We find that GDP (Y) for Belgium in 2007 is equal to the total amount of goods and services bought by those living in Belgium in 2007 (consumption = C), plus the total amount of investment items bought by Belgium’s businesses and homeowners in 2007 (I), plus the amount of new goods and services bought by the government of Belgium in 2007 (G). The final piece takes into account the fact that people, businesses, and governments outside of Belgium buy Belgium goods (exports), and that people, businesses, and the government in Belgium buy goods produced in other countries (imports). The difference between these two is captured in net exports (NX).
- Note: Because GDP trying to provide a measure of what is produced in a country for a given year, only the purchase of new goods (no used cars here) are included in the expenditure approach.
- GDP calculated this way is measured in terms of a country’s currency. For example, the GDP of Belgium in 2007 was 302 billion €. GDP measured in terms of a currency is called nominal GDP.
- If nominal GDP increased from one year to the next you would not know if is rose because Belgium produced more or if it rose because the price level in Belgium rose. Measures of real GDP remove the influence that changing prices have on GDP in order to determine whether or not a country is producing more or less from year to year.
- What determines a country’s level of real GDP and its growth rate?
- In the long run, GDP is determined by the long-run aggregate supply curve, and the growth of GDP is determined by population and technology growth. The rate at which a country should produce according to the long-run aggregate supply curve is called potential GDP.
- In the short run, GDP is determined by the aggregate demand curve and the short-run aggregate supply curve. As these curves shift, you get temporary periods of high and low growth in GDP.