EFA (8): GDP

One can hardly pick up a newspaper without reading about falls in the gross domestic product (GDP) of some country.

Germany's GDP is likely to fall by six per cent this year, while Singapore's GDP fell at an annualized rate of nearly 20 per cent in the first quarter.

But what exactly is GDP and why is it so important? This is the subject of the eighth item in our Economics for Amateurs (EFA) series. You can find this series here every Monday.

GDP is a measure of the total value of the goods and services produced by an economy — normally in a year or a quarter. It includes the output from agriculture, manufacturing and services of all kinds.

To avoid double counting, only the values of final goods and services are included, not of intermediate goods used in the production of other goods (for example, the metal used to build cars, as this is already included in the car's final price). Alternatively, one can add up the value added at each production stage.

A different measure is gross national product (GNP). Unlike GDP, which includes only the output produced within the domestic economy, GNP also includes income from abroad, such as profits from the country's companies. At the same time, GNP excludes income generated in the domestic economy that is sent abroad to foreigners.

The word "gross" in GDP and GNP means that no deduction has been made for the depreciation of the country's capital stock (factories, machinery, etc.). Making such a deduction from GNP gives net national product, otherwise known as "national income" (although this term is often used more generically, if not strictly accurately).

There is an important distinction between nominal GDP, which is valued at current prices, and real GDP, which is measures after taking out the effects of inflation.

Real GDP per head (or "per capita") is often used as a measure of living standards. There are many problems with this, however. GDP ignores unpaid housework and do-it-yourself jobs; it ignores the hidden economy and the value of leisure time; and it ignores the negative value of, for example, noise and pollution.

Regardless of these problems, most countries will be happy when their GDP figures start to rise again.