So what is so important about GDP, and why do we economists fret about it so much?
For pretty much the same reason that parents agonize over the grades that their children get in school. Grades may not be the perfect indicator of how well a child is doing, but they do happen to be universally accepted, and remain a useful method of comparing how well your child has done compared to your neighbour's.
In much the same fashion, GDP is not a perfect, all-encompassing measure for getting an idea about how well a nation did in the year past, but it is one that every country uses, and it serves as a useful guide when you run comparisons with other nations.
So how does one go about calculating GDP? One simply sums up, as I said in the previous post, all of the economic activity that went on in the economy in one accounting period. As you can imagine, however, things can get pretty complicated.
For example, economic activity by definition is a transaction. So first of all, care should be taken to ensure that you are counting all sales, or all purchases, and not some mixture of the two. In fact, when researchers step out to 'measure' GDP, they use both methods.
GDP is measured using both the expenditure and the income method. Either sum up all of the expenditures in an economy - whether done by firms, households, governments, or sum up incomes of firms, households and governments. We will, for the moment, ignore the international economy, although that is a complication we'll come back to in great detail shortly.
A third measure that is usually preferred when dealing with industrialized economies (pretty much every country in the world today, really) is known as the value-added approach. The idea in this case - and you want to follow this notion through very carefully indeed - is that GDP is nothing but the value added at each stage, taking care to not count value added in earlier stages.
For example, if you were to eat, say, a sandwich purchased from a deli, you would be eating a final product (the sandwich) which was made by purchasing a lot of other products. The meat in the sandwich, for example, has already been accounted for as income for the butcher or expenditure by the shop that purchased the meat. What should really be counted is the value added by the restaurant in cooking the meat and packaging it nicely enough within two slices of bread for you to want to eat it.
Avoiding, or not counting value produced in earlier stages of production circumvents the problem of double counting, which would inflate the total production in an economy far beyond it's actual quantity.
So there you have the three measures of GDP. In the next post, we'll think through some additional nuances that arise in the calculation of this (increasingly complicated) metric.
For pretty much the same reason that parents agonize over the grades that their children get in school. Grades may not be the perfect indicator of how well a child is doing, but they do happen to be universally accepted, and remain a useful method of comparing how well your child has done compared to your neighbour's.
In much the same fashion, GDP is not a perfect, all-encompassing measure for getting an idea about how well a nation did in the year past, but it is one that every country uses, and it serves as a useful guide when you run comparisons with other nations.
So how does one go about calculating GDP? One simply sums up, as I said in the previous post, all of the economic activity that went on in the economy in one accounting period. As you can imagine, however, things can get pretty complicated.
For example, economic activity by definition is a transaction. So first of all, care should be taken to ensure that you are counting all sales, or all purchases, and not some mixture of the two. In fact, when researchers step out to 'measure' GDP, they use both methods.
GDP is measured using both the expenditure and the income method. Either sum up all of the expenditures in an economy - whether done by firms, households, governments, or sum up incomes of firms, households and governments. We will, for the moment, ignore the international economy, although that is a complication we'll come back to in great detail shortly.
A third measure that is usually preferred when dealing with industrialized economies (pretty much every country in the world today, really) is known as the value-added approach. The idea in this case - and you want to follow this notion through very carefully indeed - is that GDP is nothing but the value added at each stage, taking care to not count value added in earlier stages.
For example, if you were to eat, say, a sandwich purchased from a deli, you would be eating a final product (the sandwich) which was made by purchasing a lot of other products. The meat in the sandwich, for example, has already been accounted for as income for the butcher or expenditure by the shop that purchased the meat. What should really be counted is the value added by the restaurant in cooking the meat and packaging it nicely enough within two slices of bread for you to want to eat it.
Avoiding, or not counting value produced in earlier stages of production circumvents the problem of double counting, which would inflate the total production in an economy far beyond it's actual quantity.
So there you have the three measures of GDP. In the next post, we'll think through some additional nuances that arise in the calculation of this (increasingly complicated) metric.
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