What does GDP mean? | Economics Explained | Helpful Economics Study Video

GDP, or Gross Domestic Product, is a measure of the total market value of all land goods and services produced within an economy's borders within a year. This is the most basic metric by which economists determine the size of an economy. Finished goods simply means goods that are not going to be used to make more goods. For example, an engine would not be counted towards GDP figures if it was put into a car, only the value of the car would be. This stops modern products with thousands of components having their value measured multiple times. It is worth mentioning, however, that if an engine is produced, and then it is sold to a customer who uses it to replace an old engine in their car, then that replacement engine would be counted towards GDP figures because it was an end good. The most common equation that economists use to calculate GDP is consumer spending plus government spending plus investments plus exports minus imports. If you add up all of these figures, you get an economy's total output, or GDP. But hang on, why are we looking at consumption and investment when trying to figure out how much stuff an economy makes? Wouldn't it make more sense to look at all of the stuff that the factories and service providers around the country are doing? Well, yes, that is certainly possible, but the problem is it's very difficult to employ millions of economists to stand at the end of every factory's production line and oversee the work of every service provider in the economy. Fortunately, consumption figures are much easier to collect and they should, theoretically, produce the same result. This happens because anything that is produced or any service that is provided will fall into one of these categories. Let's say a factory produces a water bottle. They can sell that water bottle to a consumer, they could sell it to the government, they could export it overseas, or they could hold onto it, which would count as a business investment into inventory. Now, the reason it's important for economists to subtract imports is that if a TV imported from Japan is sold in Australia, then it would add value to the consumer spending portion of Australian GDP, which would give the economist an unfair impression of how much Australia produced in that year. So, by subtracting the value of all imports, that issue just fixes itself. Calculating GDP is still a big task and requires lots of data to be collected on everything from sales taxes, export records, and government budget reports. Sometimes these figures can be open to a certain amount of interpretation, which is why GDP figures from different organisations can be slightly different. That is why it's important to use figures from the same source when comparing the size of different national economies. The World Bank and the International Monetary Fund are what most economists will use. You might have also heard of Gross National Product, and while GNP and GDP are very similar measures, they are not the same. GNP measures the total output of an economy, including the net total of output from offshore operations. For example, if an American company owned a car factory in Germany, the cars produced in that factory would not count towards American GDP figures, but they would count towards GNP figures. This is not a measure that is used nearly as much, but if you do ever need to work it out, you just take GDP and add foreign monetary inflows and subtract foreign monetary outflows. Now, economists will be quick to point out that size isn't everything, and just because an economy has a big GDP doesn't mean that it's a good place to live, or a good place to do business, or even that it runs an economy particularly well. Economies with more people in them are naturally going to have higher GDPs, all other things being equal. So this is why another common measure is GDP per capita, which is simply an economy's GDP divided by its population. Another term you should be familiar with is real GDP. Real GDP is simply GDP that has been adjusted for inflation. If GDP grows by 3% one year, but inflation is also 3%, then the economy is not really any better off. It's producing the same amount of stuff, it's just that that stuff costs 3% more. Real GDP is very important to use if you are comparing economies over long time periods. A different amount of money also buys a very different amount of things in different economies. $10,000 in the Philippines goes a lot further than $10,000 in Switzerland. That is why economists will sometimes use an adjustment called purchasing power parity, which adjusts the GDP figure up or down depending on how much a similar basket of goods costs in a different country. Economists normally use the United States as a baseline for this measurement, so all other countries' baskets of goods are compared to the same basket of goods in the USA. If their basket of goods is more expensive than the American one, then their GDP is adjusted downwards a relative amount. If their basket is cheaper than the American basket, it's adjusted upwards. Goods in China are a lot cheaper than goods in America, and that's why when adjusted for purchasing power parity, China is already the larger economy. You may have heard of the Big Mac Index, which is a very basic version of a purchasing power parity index. Although when international organizations create their figures, they do use more than just one product. Purchasing power parity is a really good tool to use, but you need to be careful about when you use it. When looking at domestic economic policies, it's great, but if you're looking at purchasing power parity figures for things like trade or international financial influence, you're just going to make yourself confused unnecessarily, because a dollar is a dollar, and you aren't going to have to pay more or less for your imports or international loans just because consumer goods are cheaper in your country. The last thing to know about GDP and all of its add-ons is that they can be combined to tell you different things. If you want to know how much GDP per capita has increased in a country over the past 10 years when adjusted for inflation, you can use real GDP per capita. If you want to know how much GDP per capita has increased in a country over the past 10 years when adjusted for inflation and purchasing power parity, you can use GDP per capita PPP.