GDP, or gross domestic product, is the market value of the final goods and services produced within a coun- try in a given time period. This definition has four parts:
Final goods and services
Produced within a country
In a given time period
If we were to add the value of intermediate goods and services produced to the value of final goods and services, we would count the same thing many times—a problem called double counting. The value of a truck already includes the value of the tires, and the value of a Dell PC already includes the value of the Pentium chip inside it.
To measure total production, we must add together the production of apples and oranges, computers and popcorn. Just counting the items doesn’t get us very far. For example, which is the greater total production: 100 apples and 50 oranges or 50 apples and 100 oranges?
GDP answers this question by valuing items at their market values—the prices at which items are traded in markets. If the price of an apple is 10 cents, then the market value of 50 apples is $5. If the price of an orange is 20 cents, then the market value of 100 oranges is $20. By using market prices to value production, we can add the apples and oranges together. The market value of 50 apples and 100 oranges is $5 plus $20, or $25.
Final Goods and Services
To calculate GDP, we value the final goods and services produced. A final good (or service) is an item that is bought by its final user during a specified time period. It contrasts with an intermediate good (or service), which is an item that is produced by one firm, bought by another firm, and used as a component of a final good or service.
For example, a Ford truck is a final good, but a Firestone tire on the truck is an intermediate good. A Dell computer is a final good, but an Intel Pentium chip inside it is an intermediate good.
Some goods can be an intermediate good in some situations and a final good in other situations. For example, the ice cream that you buy on a hot sum- mer day is a final good, but the ice cream that a restaurant buys and uses to make sundaes is an inter- mediate good. The sundae is the final good. So whether a good is an intermediate good or a final good depends on what it is used for, not what it is.
Some items that people buy are neither final goods nor intermediate goods and they are not part of GDP. Examples of such items include financial assets— stocks and bonds—and secondhand goods—used cars or existing homes. A secondhand good was part of GDP in the year in which it was produced, but not in GDP this year.
Produced Within a Country
Only goods and services that are produced within a country count as part of that country’s GDP. Nike Corporation, a U.S. firm, pro- duces sneakers in Vietnam, and the market value of those shoes is part of Vietnam’s GDP, not part of U.S. GDP. Toyota, a Japanese firm, produces automobiles in Georgetown, Kentucky, and the value of this produc- tion is part of U.S. GDP, not part of Japan’s GDP.
In a Given Time Period
GDP measures the value of production in a given time period—normally either a quarter of a year—called the quarterly GDP data—or a year—called the annual GDP data.
GDP measures not only the value of total produc- tion but also total income and total expenditure. The equality between the value of total production and total income is important because it shows the direct link between productivity and living standards. Our standard of living rises when our incomes rise and we can afford to buy more goods and services. But we must produce more goods and services if we are to be able to buy more goods and services.
Rising incomes and a rising value of production go together. They are two aspects of the same phenome- non: increasing productivity. To see why, we study the circular flow of expenditure and income.
- Market Value