Gross Domestic Product (GDP) (Encyclopedia of Business and Finance)
Led by the auto industry, the United States economy grew rapidly in the 1920s, generating more jobs, more income, and more free time that the American consumer had in order to spend. As long as people were employed, paying for goods and services, there was really no need to measure how the economy was doing. However, in the 1930s, the American economy went bust and a frustrated Congress asked if there was any way to measure the depth of the Great Depression.
On January 4, 1934, economist Simon Kuznets, professor at the University of Pennsylvania, sent to the Senate a report entitled "National Income: 1929-1932," the first accounting of U.S. productivity, essentially the gross national product (GNP). More than 4500 copies of this report were sold in just eight months. The basic concept that Kuznet had was to limit this accounting measurement to the marketplace, and thus to the amount that consumers paid for goods and services. Until 1992, the term GNP was used to refer to the total dollar value of all finished goods and services produced for consumption in society during a particular period of time (usually one year). In 1992 the Commerce Department began to compute gross domestic product (GDP) instead of GNP. The differences between the two are slight and involve how to count earning of assets owned by foreigners.
GNP counts the earnings in the homeland of the owner of the asset, while GDP counts the earnings of a manufacturer in the country in which the assets exists. For the United States, there is virtually no difference between the two measures.
There are three basic components that determine the U.S. GDP:
- Consumption, the amount that consumers pay for goods (durable and non-durable).
- Investment, the amount of money spent on new production facilities, that is, plants and facilities.
- Services, the amount that consumers pay for the services they use.
Several things were not included in GNP and subsequently in GDP:
- Work that is provided in an economy by nonmarket transactions such as homemakers and military personnel. These factors were too difficult for Kuznets and his team to measure.
- Illegal activities such as gambling and drug trafficing. These factors are also difficult to estimate; in addition Kuznets excluded them from GNP because he deemed them a "dis-service" to the economy.
- Goods and services that are bartered. These were excluded because they cannot be measured.
- Sale of intermediate goods (raw materials).
- Sale of used goods (used cars, furniture, etc.).
- Purely financial transactions such as sale of stocks and bonds.
- Imports (goods made outside the United States).
The GDP is the ultimate benchmark that measures the expansion and contraction of the U.S. multitrillion dollar national economy. It covers everything that is produced and sold in the marketplace. Bankers, investment brokers, and government officials use the GDP to determine such things as interest rates, investment opportunities, and tax rates. The GDP is not the only measure of output, however; economists use GDP because it is the most comprehensive of
Product and Prices
|Year 1||Year 2|
|Balls||10 balls||$50 per ball||10 balls||$55 per ball|
|Bats||10 bats||$25 per bat||12 bats||$25 per bat|
|Gloves||10 gloves||$50 per glove||9 gloves||$30 per glove|
output measures. This measure is important because it helps societies understand both inflation and employment.
In the flow of payments in the economy, where does one measure? Consider, for example, an automobile. The mining operator receives an income from the sale of iron ore, the mill owner receives income from the sale of finished steel, and the automobile manufacturer receives income from the sale of the finished car. In order to avoid the inaccuracy of counting the same money three times, Kuznets decided to use only final sales; thus the amount paid to the dealer for the car is the only amount used in calculating GDP. The labor cost of the workers at all three locations is added to GDP. In essence, the price of the automobile includes the cost of the materials purchased from suppliers. The value added to manufacture the automobile can be found by deducting the cost of one product from the total cost of the automobile.
The more goods and services a country produces, the healthier that country's economy becomes. There is a major flaw in measuring economic success, however, in that when GDP (production) increases, negative externalities (air and water pollution) also increase. The environment becomes degraded and negatively affects the quality of life. GDP measures goods and services traded, but the negative externalities are not included in this counting; however, these negative externalities increase GDP. For example, when the automobile industry wants to produce more cars, the smoke that is emitted from the smokestacks includes carcinogens that may make people in the area sick. A person who gets sick from the emitted smoke may go to the doctor. The doctor may prescribe medication. The cost of the visit to the doctor and the cost of the medication are added to the total value of GDP.
Table 1 contains output and price statistics for a simple economy that produces only three goods. In the first year, the value of output, or GDP, is $1000; in the second year, the GDP is $1120. These numbers are obtained by multiplying quantities by prices and then summing the resulting values. They give us current dollar or nominal GDP, that is, the value of output measured in prices that existed when the output was produced.
GDP has risen by 12 percent from the first year to the second, but this increase is only partially due to additional output ($1120 $1000 $120). Part of the increase is due to changes in prices. To get a measure that contains only the increase in output, we can multiply the outputs of the second year by the prices of the first year. When we add up these values, they total $1025. This number implies that if only the quantities of output had changed and not the prices, GDP would have increased only from $1000 to $1025, a rise of only 2.5 percent. This $1025 is real GDP.
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Gross Domestic Product (GDP) (Encyclopedia of Business)
A country's gross domestic product (GDP) is similar to its gross national product (GNP), except that GDP excludes net income from foreign sources. Like GNP, GDP is a measure of the value of a country's production of goods and services for a specific period, usually one year. Comparisons of GDP or GNP from year to year, when measured in constant dollars, indicate changes in a country's overall production and the direction of its economy. In general, economic policy makers look to the size and growth of the GNP or GDP as an indication of the well-being of the country's economy.
In the United States the GDP has replaced the GNP as the principal measure of domestic production, because it excludes foreign sources of income. It measures the output of labor and capital within the United States, while the GNP measures the output supplied by U.S. residents regardless of where they work and live. The GDP is reported at an annual rate every quarter by the U.S. Department of Commerce's Bureau of Economic Analysis. That is, the quarterly figures represent what the GDP would have been for the year had the same rate of production continued for the entire year. In addition, the quarterly figures are subject to a series of revisions until a "final revision" is made by the BEA. Analysts look to the quarterly figures for information on the direction of the economy.
As reported by the U.S. Bureau of Economic Analysis in Survey of Current Business, the United States' GDP is calculated as the sum of the four components of aggregate demand: consumption, investment, government purchases, and net exports. Personal consumption expenditures are broken out for durable goods, nondurable goods, and services. Gross private domestic investment includes fixed investment and changes in business inventories. Net exports include the value of all goods produced in the United States but sold abroad, minus the value of goods produced abroad and imported into the United States. Government purchases are reported for federal, state, and local governments. All government purchases are considered as final purchases for the purpose of calculating the GDP.
Once the GDP has been calculated, the Bureau of Economic Analysis obtains the nation's GNP by adding all receipts of factor income from the rest of the world and subtracting payments of factor income to the rest of the world. Factor income refers to income received by various factors involved in the production of goods and services, such as employees, business owners, and investors. Factor income from the rest of the world consists largely of receipts by American residents of interest and dividends and reinvested earnings of foreign affiliates of American corporations. Payments of factor income to the rest of the world consist largely of payments to foreign residents of interest and dividends and reinvested earnings of American affiliates of foreign corporations.
[David P. Bianco]
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