Gross Domestic Product (GDP)
To determine the health of the economy a basic measurement nations use is Gross Domestic Product, or GDP. GDP is the total of all goods and services produced within a country's borders within a given year.
The first important distinction concerning GDP is that it includes all good and services produced in a country, regardless of where the company is headquartered. For instance, the Mercedes cars produced in the United States are counted in the United States' GDP, even though Mercedes is a German-owned company. Ford cars that are produced in Mexico are not included in the United States' GDP, even though Ford is a United States-owned company.
Another aspect of GDP is that it only includes final goods and services produced. This is done to avoid double counting. For example, car companies purchase tires to place on their new cars. The tires are considered intermediate goods and are not counted in GDP. The cost of the tires will be accounted for in the price of the new car, which will be counted in GDP. On the other hand, replacement tires, and other replacement or add-on "after-market" auto parts, are counted in the GDP.
Calculating GDP
What is counted when calculating GDP?
To calculate GDP, economists use the equation GDP = C + I + G + X, where:
C = Consumer spending (or Consumption)
I = Business investment
G = Government spending
X = Net exports (expressed as Exports - Imports)
Note: Consumer spending is the largest component of GDP.
What is not counted when calculating GDP?
Only goods or services that are produced in a given year are counted. If you buy a used car or house they are not counted in GDP because the car and house were already included in a previous count. Any financial transaction or transfer payment is not included in GDP since nothing was produced. If money is simply transferred from one person to another, that is not counted. Leisure time is not counted because it would be hard to quantify the benefit a person receives from taking it easy. Work that someone does for themselves is not counted. The work that housewives and househusbands complete is not added to GDP. Many people believe this is an indication that GDP is underrepresented. If you pay for your clothes to be cleaned at a dry cleaners, that is included in GDP but if you do your own laundry, the value of your laundry service is not included in GDP.
Watch Gross Domestic Product (3:23) to learn about ways of calculating GDP. Take the quiz at the end of the video for practice!
Read GDP: Does it measure up? to learn more about how GDP is calculated, and the importance of a growing economy to a nation and its workforce.
Watch Economic Growth (4:36) to learn about the importance of economic growth.
Per Capita GDP
While GDP is important, per capita GDP is a much better indicator of how a country is doing according to their standard of living. The United States currently has the highest GDP of any nation in the world at $16.8 trillion. China has the second highest GDP of $9.2 trillion.
This comparison can be deceiving unless you compare the per capita GDP of each nation. China has an estimated population of 1.3 billion. Dividing the country's GDP by its population gives a per capita GDP of only about $6,800. The per capita GDP in the United States is around $53,000. While the United States has an impressive per capita GDP compared to China, use this GDP per capita to determine their positions relative to the rest of the world.