The Measurement of Gross Domestic Product

Having discussed the meaning of gross domestic product in general terms, let’s be more precise about how this statistic is measured. Here is a definition of GDP that focuses on GDP as a measure of total expenditure:

• Gross domestic product (GDP) is the market value of all final goods and services produced within a country in a given period of time.
This definition might seem simple enough. But in fact, many subtle issues arise when computing an economy’s GDP. Let’s therefore consider each phrase in this definition with some care.

“GDP Is the Market Value . . .”
You have probably heard the adage, “You can’t compare apples and oranges.” Yet
GDP does exactly that. GDP adds together many different kinds of products into a single measure of the value of economic activity. To do this, it uses market prices.
Because market prices measure the amount people are willing to pay for different goods, they reflect the value of those goods. If the price of an apple is twice the price of an orange, then an apple contributes twice as much to GDP as does an orange. “. . . of All . . .”
GDP tries to be comprehensive. It includes all items produced in the economy and sold legally in markets. GDP measures the market value of not just apples and oranges but also pears and grapefruit, books and movies, haircuts and healthcare, and on and on.
GDP also includes the market value of the housing services provided by the economy’s stock of housing. For rental housing, this value is easy to calculate— the rent equals both the tenant’s expenditure and the landlord’s income. Yet many people own the place where they live and, therefore, do not pay rent. The government includes this owner-occupied housing in GDP by estimating its rental value.
In effect, GDP is based on the assumption that the owner is renting the house to himself. The imputed rent is included both in the homeowner’s expenditure and in his income, so it adds to GDP.
There are some products, however, that GDP excludes because measuring them is so difficult. GDP excludes most items produced and sold illicitly, such as illegal drugs. It also excludes most items that are produced and consumed at home and, therefore, never enter the marketplace. Vegetables you buy at the grocery store are part of GDP; vegetables you grow in your garden are not.
These exclusions from GDP can at times lead to paradoxical results. For example, when Karen pays Doug to mow her lawn, that transaction is part of GDP. If Karen were to marry Doug, the situation would change. Even though Doug may continue to mow Karen’s lawn, the value of the mowing is now left out of GDP because Doug’s service is no longer sold in a market. Thus, when Karen and Doug marry, GDP falls.

“. . . Final . . .”
When International Paper makes paper, which Hallmark then uses to make a greeting card, the paper is called an intermediate good, and the card is called a final good. GDP includes only the value of final goods. This is done because the value of intermediate goods is already included in the prices of the final goods. Adding the market value of the paper to the market value of the card would be double counting. That is, it would (incorrectly) count the paper twice.
An important exception to this principle arises when an intermediate good is produced and, rather than being used, is added to a firm’s inventory of goods for use or sale at a later date. In this case, the intermediate good is taken to be “final” for the moment, and its value as inventory investment is included as part of GDP.
Thus, additions to inventory add to GDP, and when the goods in inventory are later used or sold, the reductions in inventory subtract from GDP.

“. . . Goods and Services . . .”
GDP includes both tangible goods (food, clothing, cars) and intangible services
(haircuts, housecleaning, doctor visits). When you buy a CD by your favorite band, you are buying a good, and the purchase price is part of GDP. When you pay to hear a concert by the same band, you are buying a service, and the ticket price is also part of GDP.

“. . . Produced . . .”
GDP includes goods and services currently produced. It does not include transactions involving items produced in the past. When Ford produces and sells a new car, the value of the car is included in GDP. When one person sells a used car to another person, the value of the used car is not included in GDP.

“. . . Within a Country . . .”
GDP measures the value of production within the geographic confines of a country.
When a Canadian citizen works temporarily in the United States, her production is part of U.S. GDP. When an American citizen owns a factory in Haiti, the production at his factory is not part of U.S. GDP. (It is part of Haiti’s GDP.) Thus, items are included in a nation’s GDP if they are produced domestically, regardless of the nationality of the producer.

“. . . In a Given Period of Time.”
GDP measures the value of production that takes place within a specific interval of time. Usually, that interval is a year or a quarter (three months). GDP measures the economy’s flow of income and expenditure during that interval.
When the government reports the GDP for a quarter, it usually presents GDP
“at an annual rate.” This means that the figure reported for quarterly GDP is the amount of income and expenditure during the quarter multiplied by 4. The government uses this convention so that quarterly and annual figures on GDP can be compared more easily.