Now we’ve seen the various ways that gross domestic product is calculated. But what does the measurement of GDP tell us?
The most important use of GDP is as a measure of the size of the economy, providing us a scale against which to measure the economic performance of other years or to compare the economic performance of other countries. For example, suppose you want to compare the economies of different nations. A natural approach is to compare their GDPs. In 2013, as we’ve seen, U.S. GDP was $16,800 billion, China’s GDP was $9,181 billion, and the combined GDP of the 27 countries that make up the European Union was $17,371 billion. This comparison tells us that China, although it has the world’s second-
Still, one must be careful when using GDP numbers, especially when making comparisons over time. That’s because part of the increase in the value of GDP over time represents increases in the prices of goods and services rather than an increase in output. For example, U.S. GDP was $8,608 billion in 1997 and had approximately doubled to $16,800 billion by 2013. But the U.S. economy didn’t actually double in size over that period. To measure actual changes in aggregate output, we need a modified version of GDP that is adjusted for price changes, known as real GDP. We’ll see next how real GDP is calculated.
Creating the National Accounts
The national accounts, like modern macroeconomics, owe their creation to the Great Depression. As the economy plunged into depression, government officials found their ability to respond crippled not only by the lack of adequate economic theories but also by the lack of adequate information. All they had were scattered statistics: railroad freight car loadings, stock prices, and incomplete indexes of industrial production. They could only guess at what was happening to the economy as a whole.
In response to this perceived lack of information, the Department of Commerce commissioned Simon Kuznets, a young Russian-
Kuznets’s initial estimates fell short of the full modern set of accounts because they focused on income, not production. The push to complete the national accounts came during World War II, when policy makers were in even more need of comprehensive measures of the economy’s performance. The federal government began issuing estimates of gross domestic product and gross national product in 1942.
In January 2000, in its publication Survey of Current Business, the Department of Commerce ran an article titled “GDP: One of the Great Inventions of the 20th Century.” This may seem a bit over the top, but national income accounting, invented in the United States, has since become a tool of economic analysis and policy making around the world.
A country’s national income and product accounts, or national accounts, track flows of money among economic sectors.
Households receive factor income in the form of wages, profit from ownership of stocks, interest paid on bonds, and rent. They also receive government transfers.
Households allocate disposable income between consumer spending and private savings—
Government purchases of goods and services are total expenditures by federal, state, and local governments on goods and services.
Exports lead to a flow of funds into the country. Imports lead to a flow of funds out of the country.
Gross domestic product, or GDP, can be calculated in three different ways: add up the value added by all firms; add up all spending on domestically produced final goods and services, an amount equal to aggregate spending; or add up all factor income paid by firms. Intermediate goods and services are not included in the calculation of GDP, while changes in inventories and net exports are.
Explain why the three methods of calculating GDP produce the same estimate of GDP.
What are the various sectors to which firms make sales? What are the various ways in which households are linked with other sectors of the economy?
Consider Figure 7-2 and suppose you mistakenly believed that total value added was $30,500, the sum of the sales price of a car and a car’s worth of steel. What items would you be counting twice?
Solutions appear at back of book.