The Gross Domestic Product
September 20, 2009
Definition 1 GDP: the value of goods and services produced in the domestic
economy over a given period of time.
• Domestic Economy : factors of production (human and nonhuman) located
on domestic soil
— as distinct from National Economy : factors of production (human and
nonhuman) owned by citizens
— replace ‘domestic’ with ‘national’ in definition above and get GNP
• Value: a measurement criterion
— e.g., measured in dollars at current market prices (the nominal GDP)
— properly, value-added only (intermediate goods and services excluded)
• Time: a measurement criterion
— e.g., per month, per quarter, per annum
In a nutshell: GDP is a measure of the flow of goods and services produced
(output, for short)
• flow as distinct from stock (think of your bathtub)
Definition 2 Capital: an existing stock of goods
• sometimes called physical capital (as distinguished from financial capital
or human capital)
• a factor of production; or inventory
Definition 3 Capital consumption: the value of capital destroyed in the process
of production or storage
• also referred to as capital depreciation
• the term gross in GDP refers to production gross of capital consumption
Output is frequently classified as either consumption or investment...
Definition 4 Consumer goods and services: output that is destroyed for the
purpose of augmenting current material living standards
Definition 5 Investment goods and services: output that is used to augment
the future stock of capital
• since capital is a factor or production, and since investment augments
future capital, it follows that investment today expands future production
• consumer goods augment material living standards in current period; investment in future periods (suggests an intertemporal trade-off)
How the GDP is Calculated
• Expenditure Approach: total spending on all domestically-produced final
goods and services
• Basic idea is that all production is sold
• Therefore, to compute the value of production, just count up the value of
sales
• Note: “unsold” goods are counted as a purchases of inventory (investment)
• Note: many goods and services are not “sold;” so expenditure is sometimes
“imputed;” e.g.,
— expenditure on shelter provided by owner-occupied housing
— expenditure on government-produced services that are provided for
“free”
• If () is quantity of output  produced during period  and () is price;
then expenditure-based GDP is
 ≡
X

()()
Dividing GDE by Sectors and Product Classes
• No unique way of doing this, but traditionally
— Sectors: [1] Household, [2] Business, [3] Government, [4] Foreign
— Product classes: [1] Consumption, [2] Investment
• Traditional (but not the most logical) way to decompose GDE is
 ≡ [ +  +  + ] − 
— note: imports () subtracted off because    all include expenditure on imports
• Income Approach: total income generated by all domestic factors of
production
• Basic idea is that every expenditure constitutes income for someone on the
other side of the transaction
• Therefore, to compute the value of production, just count up the income
that is derived from its production and sale
• If () is quantity of domestic input  used in production at date  and
() is input price, then income-based GDP is
 ≡
X

()()
• Note: income does not include taxes or transfers
• Note: income measure sometimes used to impute expenditure; e.g.,
— if () is shelter from owner-occupied home, then use observed rental
price () on similar unit to impute expenditure ()()
— if () is government worker providing a “free” service and () is
wage, then assume that ()() is the value of what is produced
and “purchased”
The Income-Expenditure Identity
• Let  ≡ 
• Then using the fact that  ≡  we have
 ≡  +  +  +  
where   ≡  −  (net exports)
• Note: this is not theory; it is simply accounting
• In particular, while the identity is true (by definition), it does not imply
any causal relationship between the measured variables
Nominal vs Real GDP
• Nominal GDP is GDP measured in current prices (stated in units of currency); e.g.,
 ≡
X
()()

• Real GDP is GDP measured in base-year prices (stated in units of currency);
e.g.,
 ≡
X
()()

where  is an arbitrary base-year
• GDP deflator (a measure of the price-level) is  ≡ 
Real Per Capita GDP
• Since GDP is equivalent to income, a measure of average income
• Used as a broad measure of material living standards (consumption is
arguably a better measure)
• Use caution in making cross-country comparisons
— measured GDP in LDC understated (home production not counted in
GDP)
Data
• Large and persistent differences in real per capita GDP across countries
• Output tends to grow over time (roughly 2% per annum over the last 100
years in developed economies)
• Some LDCs display rapid periods of growth for decades (recently, China
and India); while others lag behind (Zimbabwe, N. Korea)
• Pattern of development is uneven, especially in short-run (business cycles)
• Some disagreement on long-term (growth) patterns; much more disagreement on short-term (business cycle) patterns