Gross Domestic Product

What is Gross Domestic Product, otherwise known as GDP? Gross Domestic Product is the market value of all finished goods and services produced within a country in a year. Think about the economy like a giant supermarket filled with millions of goods, like dresses, and washing machines, and services, like dog walking and massages. Every time a finished good or service is sold, we ring up the price. At the end of the year, we ring up the total -- that's the GDP.

Let's look more closely at some of the details. Notice that we said GDP is the market value of all finished goods and services. A finished good or service is one that will not be sold again as part of some other good. When a bakery buys flour, eggs, and butter, we don't count these sales in GDP because these goods aren't finished. They are intermediate goods that, when combined, will become a finished good -- a cake, for example. But, if a consumer buys an egg to make an omelet, the egg is a finished good because it won't be sold again as part of some other good. In other words, our GDP supermarket is like a real supermarket. At the GDP register, we ring up the eggs sold to consumers, and the cakes, but we don't ring up the eggs the baker used to make the cake.

There are also goods that are used to make other goods, but are still considered finished goods. These are called capital goods. If Caterpillar produces a tractor and sells it to a farm, the tractor is considered a finished good. The tractor is finished and its value is added to the GDP. Although the tractor is used to make other goods, it won't be sold again as part of another good, so the tractor is still a finished good. The GDP is the market value of all finished goods and services produced within a country in a year. GDP only counts production. If an old house is sold this year, that doesn't add to GDP since the house wasn't produced this year. Only the sale of new houses add to GDP. GDP also only counts goods and services produced within a country. If you buy a bottle of wine imported from France, that adds to France's GDP, not to U.S. GDP. On the other hand, a computer produced in the United States and exported to France adds to the U.S. GDP.

Let's go back to the definition one more time, to see some of the limits of GDP as a measure of economic production. GDP is the market value of all finished goods and services produced within a country in a year. If a good isn't bought and sold in a market, then it's not typically counted in GDP. Why not? Counting the market value of, say, all the breakfast cereal produced in the U.S. is easy, at least in principle. Just add up the price every time a box of cereal is sold. Since market prices are observable, every statistician who counts carefully will come up with pretty much the same number. But, without market prices, there's no easy or agreed upon way to calculate how much a good is worth. Polar bears, for example, aren't counted in GDP.

The statisticians and economists who calculate GDP have nothing against polar bears. The problem is that there's no easy way to calculate how valuable polar bears are. Just because GDP doesn't include polar bears doesn't mean that we can't love polar bears. And if polar bears were included in GDP, that wouldn't require us to love polar bears either. Ultimately, GDP is just a number. But it's a useful number. In the next few videos, we'll show how the GDP number can be used as a measure of the standard of living. But for that, we'll have to make a distinction between the Nominal GDP, what we have just discussed so far, and Real GDP. So, stay tuned.