Gross Domestic Product (GDP) is an economic measure of a nation's total income and output for a given time period (usually a year). Economists use GDP to measure the relative wealth and prosperity of different nations, as well as to measure the overall growth or decline of a nation's economy.
What are the advantages and disadvantages of Gross Domestic Product?
The most common way to measure GDP is the expenditure approach. With the expenditure approach, GDP is the sum of the following elements:
- Total domestic consumption: This is the total amount spent on domestically produced final goods and services. Final goods are items that will not be resold or used in production within the next year — milk, cars, bow ties, and so on.
- Total domestic investment expenditures: This measurement includes not only investments in stocks and bonds, but also investments in equipment — such as bulldozers, computer servers, and commercial buildings — that will be useful over a long period of time. It also includes inventory goods — final goods waiting to be sold that a company still has on hand.
- Government expenditures: This includes everything from paying military salaries to building roads and maintaining monuments, but does not include welfare and social security payments.
- Net exports: Net exports is the total of goods and services produced domestically and sold to foreigners minus goods and services produced by foreigners but sold domestically (imports).
Using GDP as a measure of a nation's economy makes sense because it's essentially a measure of how much buying power a nation has over a given time period. GDP is also used as an indicator of a nation's overall standard of living because, generally, a nation's standard of living increases as GDP increases.
But there are a number of shortcomings to using GDP. Here are just a few:
- GDP doesn't count unpaid volunteer work: GDP doesn't take into account work that people do for free, from an afternoon spent picking up litter on the roadside to the millions of man-hours spent on free and open source software (such as Linux). In fact, volunteer work can actually lower GDP when volunteers do work that might otherwise have gone to a paid employee or contractor.
- Disasters can raise GDP: Wars require soldiers, oil spills require cleanup, and natural disasters require health workers, builders, and all manner of helping hands. Rebuilding after a disaster or war can greatly increase economic activity and boost GDP.
- GDP doesn't account for quality of goods: Consumers may buy cheap, low-quality, short-lived products repeatedly instead of buying more expensive, longer-lasting goods. Over time, consumers could spend more replacing cheap goods than they would have if they had bought higher-quality goods in the first place, and GDP would grow as a result of waste and inefficiency.
Although economists are constantly working on other ways to measure an economy, GDP is still the best indicator of a nation's overall economic health, in spite of its shortcomings.